Uncle Sam's EE savings bonds used to be an attractive deal. Introduced in the early 1980s, these safe bonds (backed by the "full faith and credit of the United States government") once paid an impressive 11% interest rate. Part of that was variable, but the fixed portion was as high as 7.5%. Sadly, the key words above are "used to be."
Today's EE bonds pay a paltry fixed rate of 0.5% (the rate for new bonds is set each May 1 and November 1). So, if you buy a $1,000 piece of our country's massive debt, you can rest assured that after a year it'll be worth a whopping $5 more. There's no longer a variable part of the rate. That went away for all EE bonds issued after May 1, 2005.
Adding to the unattractiveness of EE savings bonds is their illiquidity. You have to hold these bonds for at least one year. Cash in before five years and you'll forfeit three months' interest. Who needs that when online banks currently pay higher interest rates on savings accounts while offering complete liquidity?
Do EE bonds ever make sense?
So, why would anyone buy an EE savings bond today? Well, the picture improves a little bit for long-term savers, and a little bit more for long-term college savers. But not much.
If you're willing to hold an EE savings bond for 20 years, Uncle Sam will work his government-style accounting magic and guarantee your initial investment will be worth twice what you paid for it, which works out to an annualized return of 3.5%. Cash in at 19 years and you'll get a 0.5% annual return. Cash in at 20 and you'll get a 3.5% return. Don't ask why.
While 3.5% is far better than 0.5%, in today's economic environment where interest rates seem likely to rise, locking into a 3.5% rate for 20 years is a tough sell for all but the most conservative savers.
While 20 years is the original maturity date, EE bonds continue earning interest up to their final maturity date, which is 30 years from the issue date. However, during this 10-year "extended maturity period," the bonds revert to earning the rate set when issued (currently 0.5%). So there's little reason to hold low issue-rate bonds past the 20-year mark.
EE savings bonds used to be a popular vehicle for college savers. Most people will owe federal income tax on the interest they earn from EE savings bonds upon redemption or final maturity. However, if you buy EE bonds in your name (not your child's) and use the money for his or her tuition or other qualified college costs (room/board and books don't qualify) — and if your income is below certain thresholds — you'll owe no federal income tax on the interest. Interest earned on EE bonds is always free of state/local taxes.
For example, assume you buy $10,000 of EE bonds for your newborn child. If you hold those bonds for 20 years to get the 3.5% annual return, your $10,000 investment will be worth $20,000, which could be used to help pay for your child's final year or two of college. Because you won't owe tax on the interest, if you are in the 28% tax bracket at that point, your tax-equivalent return is 4.86%.
Still, with a 20-year time frame, you'd likely do better in a Coverdell Education Savings Account or 529 plan. Both of these college-saving vehicles offer the same tax advantages of EE savings bonds used for college.
If, nevertheless, you decide to buy
EE savings bonds used to be conveniently sold through banks, but no longer. Now they're sold online at face value (www.TreasuryDirect.gov) in minimum values of $25. You can buy up to $10,000 worth of bonds per year. You then redeem your bonds through the U.S. Treasury, receiving the face value plus accrued interest.
Unfortunately, this means the days of tucking a U.S. savings bond into a birthday or wedding card have passed. The government stopped issuing paper bonds in 2012. The best you can do is print a far less impressive-looking gift certificate from the Treasury's website.
Search your sock drawer
While you may not want to buy any new EE bonds, you may already own some. According to the Treasury Department, "Billions of dollars in savings bonds have stopped earning interest," but are sitting unredeemed in sock drawers or safe deposit boxes. To see if you own any forgotten bonds, search the government's Treasury Hunt database.
For savings bonds you do know about, you can find information about their maturity date, value, etc. by using the Treasury's online tools.
The bottom line on EE savings bonds: their current interest rate makes them unattractive even for long-term savers, including college savers. But it's worth finding out if you own a bond or two that you've forgotten about. And if you know you own bonds, it's worth investigating the maturity dates and deciding on the optimal time to redeem them. That way you'll avoid joining those who still own savings bonds long after they've stopped paying interest.