U.S. savings bonds seen making a comeback

Remember that you’re not going to get that yield forever. Those future variable rates may be higher — or lower — than the one currently in place. If inflation falls, the next rate your bond earns will be lower than what it is now. So if it turns out that inflation runs at only 1 percent in the coming months, a Series I bond you buy today will earn interest at an annualized rate of just 2 percent for the six months starting in May.

But if inflation rises, your bond could earn even more. Inflation is hard to project, but “if you watch rates going on, you’ll see general increases across the entire economy, such as home mortgage rates, and that gives a flavor that rates will go up again," said John Quinn, CEO of SavingsBonds.com, an informational Web site about savings bonds. "By just how much, no one can say.”

Even though savings bonds are safe, they do not provide immediate income since the interest payments build up and are accessible only when you redeem the bond. You can’t do that until you've owned the bond for at least 12 months, so don’t buy one if you think you’ll need the money before then. And if you redeem in the first five years, you lose the last three months' interest earnings.

“But if the bonds paid 6.73 percent for the next 12 months, you could redeem them a year from now and still have made a healthy 5 percent, even with the three-months' interest penalty,” says Quinn.

Being bullish on I-bonds, Quinn recommends buying them on a regular basis. “You can hedge your bets by buying $1,000 a month for six months and if the rate goes up, you can cash in that and buy another bond. The actual dollar amount lost by cashing them in before five years is offset by the new rate being higher.”

Tax-free benefits
Like retirement funds, savings bonds are federal tax-deferred till you cash them out. Plus, interest is free from state and local tax. Adams recommends that bondholders ideally cash them out in a year when income is relatively low since interest is taxed as ordinary income.

And regarding the old-fashioned aspect of savings bonds being grandparents’ gifts, Quinn says one of the best things grandparents can do is to buy their beloved grandchildren savings bonds.

“If a child receives the bond, that child has a tax exemption of up to $800 in income. So if the bond earns $15 to $20 worth of interest and you report it on your child’s tax return, it won’t be taxed because of the exemption. If they’re given bonds annually until they’re 18, they don’t have a tax liability because they reported that interest year after year. You can cash those in and pay for college without any tax burden.”

So they may not be sexy, but savings bonds are proof that slow and steady wins the race. “No single investment in the stock market guarantees that type of percentage year over year,” says Adams. “If you expect the worst when it comes to investing, this is the way to go.”

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