I recently wrote about the fact that my wife and I were buying some Series I Savings Bonds. Following that post, I received several inquiries as to the differences between the two main flavors of savings bonds, known as “I Bonds” and “EE Bonds.” What follows is a brief comparison of the two.
As I’ve noted in the past, the I Bond interest rate is made up of two components, a fixed rate and a variable rate. The variable rate is intended to reflect recent inflation rates (CPI-U), whereas the fixed rate essentially represents a premium over inflation.
In the case of EE Bonds, your investment is subject to a fixed rate of return that is set at purchase. Things can, however, get a little strange when it comes to purchasing EE Bonds. The reason for this is that online and paper purchases are treated somewhat differently.
When purchasing online, EE Bonds are bought at face value and they earn the fixed rate for up to 30 years (20 years + a 10 year “extended maturity” period). Beyond this, these bonds are guaranteed to double in value no later than 20 years after purchase. If the value hasn’t doubled at this point, the Treasury will make a one-time adjustment to make up the difference.
Paper EE Bonds are likewise subject to a fixed rate of return, but you purchase them at half of face value, and can then redeem them for face value at maturity. In other words, they’ll still double over 20 years.
Using the Rule of 72, you can easily determine that this doubling in 20 years works out to a minimum annual return of slightly better than 3.50% — assuming you hold them to maturity. If you break your EE Bonds early, you’ll receive your principal plus the accrued interest (minus penalties) based on the applicable fixed rate.
Both I Bonds and EE Bonds can be redeemed as soon as 12 months after purchase, though there is a penalty of 3 months of interest if you redeem within 5 years. These bonds technically mature in 20 years, though you can continue earning the applicable fixed rate for an additional 10 years after that.
You are limited to purchasing $5k worth of Savings Bonds per year per social security number through each of two channels — electronic and paper. Electronic bonds purchases are made online at TreasuryDirect, whereas paper purchases can be made in person at most banks.
This purchase limit applies separately to I Bonds and EE Bonds, so you could actually buy up to $10k ($5k electronic and $5k paper) of each type per social security number, or $20k combined in any given year.
Interest payments on both I Bonds and EE Bonds are exempt from state and local income taxes (yay!). This means that their tax equivalent yield will be higher than for equally priced, fully taxable bonds.
In addition, the federal taxes on income from both I Bonds and EE Bonds can be deferred until redemption. And guess what? If you use the proceeds to pay for college education, the interest will ultimately be income tax free (subject to restrictions; details).
Which is the better? I Bonds or EE Bonds?
So which is a better investment? I Bonds or EE Bonds? I’m not in the business of offering personalized financial advice, but I’m perfectly willing to share with you what we’re doing…
We recently purchased our annual allotment of I Bonds, and will likely continue to do so in coming years. In recent years, I Bonds have typically outpaced EE Bonds, and they also provide a bit of inflation protection for what is essentially (after 12 months) a liquid investment.
The downside of I Bonds is that they could earn very, very little in periods of deflation. In fact, the inflation rate was sufficiently negative during the Great Recession that the variable rate wiped out the fixed rate, and I Bonds yielded 0% for awhile.
Of course, this is just one piece of our overall asset allocation puzzle, so don’t read too much into it. We’re also heavily invested in both the stock and bond markets (via index funds).
What about you? Do you have savings bonds as part of your investment portfolio? If so, which do you prefer, I Bonds or EE Bonds?