Safety, liquidity and yield are three factors that your clients seek for at least some of their portfolio. But those attributes are difficult to find these days, especially in one investment. Yet it’s still possible to get a great interest rate on a safe bond, with some tax advantages in addition. You just have to be willing to wait a while for the big payoff.
Savings Bond Basics
Series EE savings bonds are direct obligations of the United States Treasury. They are available for purchase online at www.treasurydirect.gov, and mature after 30 years. The annual interest rate for Series EE savings bonds is currently a paltry 0.1 percent, which is in effect for the life of the bond. But a little-known twist can make that rate a whole lot better.
Double Your Money
The U.S. Treasury currently guarantees that holders of Series EE savings bonds will double their initial investment, once the bonds have been held for at least 20 years. That would work out to about a 3.5 percent annual yield, which compares very favorably to the 2.27 percent that the 20-year Treasury bond paid as of Oct. 28, 2016. But unlike the Treasury equivalent, holders of Series EE bonds have no risk of a market-induced loss.
It’s difficult to redeem savings bonds within the first year of investment. During the first five years of ownership, there is a miniscule penalty of three months’ worth of interest if the money is withdrawn. After five years, there is no penalty for redeeming the bonds.
Also unlike the Treasury equivalent, Series EE bondholders who redeem the bonds before the 20-year holding period will only earn that 0.1 percent annual interest rate.
U.S. savings bonds hold another unique advantage over Treasury securities. Like Treasurys, the interest on savings bonds is exempt from state taxation.
But savings bond holders can choose to either declare the interest (and pay taxes on it) as the interest is earned each year, or wait until the bonds mature (or are redeemed early) and pay the taxes on all of the accrued interest.
Clients who are saving for common goals like retirement or college can use this feature to their advantage.
Hopefully your working clients are maxing out opportunities to save all they can into 401(k)s, IRAs and Roth IRAs. Those who still have money left over should consider purchasing Series EE savings bonds with any extra funds. In the short term, they will get yields equivalent to rates currently paid on money market accounts, along with maximum liquidity and safety.
But if the clients can hold the bonds for two decades, they will receive a 100 percent total return on their initial investment, and can cash the bonds in with no penalty to either spend as they please or invest elsewhere. Yes, there will be taxes due on the interest at that time. But since the clients will be retired, they will likely be in a lower tax bracket than if they had declared the interest while working.
Covering College Costs
Certain clients will be interested in using the Series EE money-doubling loophole as a tool to save for higher education expenses. Let’s say the parents of a newborn baby purchase $10,000 of Series EE savings bonds today, in their name. They would choose to defer paying taxes on the interest until the bonds are redeemed, or mature in 30 years. In 20 years those bonds will be worth $20,000. If the parents then redeem the bonds and also pay for qualified higher education expenses in the calendar year of redemption, the interest could be tax-free. That is, if the parents’ income in that year is below certain limits, which won’t be known until that time.
For 2016, the full interest exclusion is available only to married couples filing jointly with adjusted gross income of less than $115,751 ($77,200 for single filers), and phased out entirely at $145,750 for couples and $92,000 for single filers. Those figures are adjusted upward each year for inflation. A complete discussion of the exemption (including a listing of the qualified expenses) can be found in Form 8815 at www.irs.gov.
Grandparents are not eligible to use the higher education interest exemption for savings bonds proceeds, unless they count the grandchild in question as a dependent. But they could gift funds to the parents of the grandbaby now, with the understanding that the money will be used to purchase savings bonds owned by the parents.
A Gift That Keeps on Giving
Although grandparents probably can’t benefit from the tax break for higher education expenses, they can certainly still purchase savings bonds for their grandchildren as gifts. They can either buy the bonds now using the name and Social Security number of the child in question or purchase the bonds in their own name today and decide at some point to transfer the bonds to the grandchild’s ownership (or not). The TreasuryDirect website even provides a gift certificate that the givers can customize, print out and present to the recipients.
There are a few downsides to savings bonds that your clients should know. First, the bonds can’t be purchased in tax-sheltered retirement accounts like IRAs and Roth IRAs. Although savings bonds can be bought for as little as $25, the maximum annual amount individuals can purchase is $10,000 per person per calendar year.Then there is the purchasing process. New Series EE savings bonds can only be purchased by the client, who has to visit the TreasuryDirect website to open an account, make the purchase and initiate the transfer of funds required to pay for the purchase.
Warn the client that they should set aside several hours for the initial process, but future purchases are usually a little quicker and easier. After the client is done going through all that trouble, they’ll not only appreciate your recommending an investment that earns you nothing, but they’ll have a greater amount of gratitude for how much easier it is to invest directly through you.