Savings Bonds' Swan Song?

By Jane Bryant Quinn
Sunday, September 21, 2008

If the government didn't deny it, I'd swear it was trying to get rid of U.S. savings bonds.

In January, the Treasury Department made the bonds all but useless to financial planners and other savvy investors who bought them to capture high short-term interest rates. In May, the fixed-rate portion of the interest on Series I bonds, whose interest payments are linked to inflation, was set at zero.

The inflation-linked portion of the Series I bond rate came in at 4.84 percent, so it's still attractive. But current buyers won't earn a dime more than the inflation rate over the bonds' 30-year life.

You want more? In 2003, Congress eliminated the marketing budget for savings bonds, so there's no one encouraging people to buy. In 2005, the Treasury stopped paying variable market rates on Series EE bonds. Now it fixes the rate -- with new bonds at a meager 1.4 percent for 30 years. That's not a worthwhile buy for a child's birthday gift, let alone a way for the average American to save.

The Treasury's gripe against savvy investors seems to be that they were doing too well. Series I bonds often yield more than Treasurys of comparable terms, and all the interest is tax-deferred. Planners were piling into them for part of their clients' conservative portfolios.

No more. The government slashed the amount of money you're allowed to invest in savings bonds. Formerly, you could put as much as $30,000 a year into paper Series I bonds and another $30,000 into the electronic version -- $60,000 in all. In January, the Treasury dropped the maximum to $5,000 for each type of purchase. That's not enough to make a dent in most managed accounts.

The new $5,000 maximum applies to Series EE bonds, too, but their rates are too low to even consider.

Also in January, the minimum purchase for Treasury bills, notes and bonds was dropped to $100 from $1,000, making them a potential option even for smaller savers.

Interest rates on savings bonds change every May and November, so you don't know what you'll earn over your holding period. But compared with Series I bonds at 4.84 percent, five-year Treasury notes yield about 3 percent. (You have to hold savings bonds for at least five years to avoid paying a three-month interest penalty at redemption.)

One-year Treasury bills yield about 2 percent. If you bought Series I bonds, held them for one year as required, then redeemed them and paid the penalty, you would come out well ahead -- that is, if the money were worth your time.

Here's another reason for thinking that savings bonds are on the endangered list. In 2003, the Treasury announced that savings-bond sales would soon be switched entirely to TreasuryDirect.gov, eliminating paper bonds. Savers -- even those with only $50 -- would have to set up the same type of electronic account used by investors who put $50,000 into Treasury bills.

That was a thumb in the eye of small savers, for whom Series I bonds offer the only chance of earning decent returns. Many of them don't have 24/7 access to a computer and don't manage their finances online. Some of the older generation don't use the Web at all (poster child: John McCain).

Since that announcement, the date for eliminating paper bonds has been delayed. When -- and if -- it arrives, some buyers will move to the Web, but sales to small savers will still decline, probably a lot. Currently, 92 percent of savings bonds are purchased as paper securities.

Like most banking institutions, the government -- or at least the recent Congresses and the Treasury -- can't be bothered with the little guy.

But little guys need and want to save. Historically, that was the other purpose of savings bonds, along with raising money for the government. Peter Tufano, a professor at Harvard Business School, together with the nonprofit Doorways to Dreams Fund is studying whether that purpose can be revived.

Tufano proposes that people be offered a chance to buy Series I bonds with part of their income-tax refunds. He's been testing this idea over three tax-filing seasons at a handful of offices of the tax preparer H&R Block and the IRS-funded Volunteer Income Tax Assistance Program. Selected taxpayers due a refund of more than a certain amount were asked whether they would like to participate.

Anywhere from 4.5 to 9 percent of the taxpayers said yes, depending on the study. In the 2008 filing-season test, 64 percent of the buyers had no other savings or investments. Of those with savings, more than half had a balance of $1,000 or less. They put an average of $186 into the bonds. If they bought in the previous year, they were more apt to buy again.

These savers were also trying to help others -- 68 percent of them put co-owners on the bonds, primarily children.

Tufano was in Washington recently, presenting his findings to the Treasury. He's hoping to interest the government in backing a tax-time "RefundSaver" program, to give lower earners a way to capitalize on their thrift.

To achieve this, of course, a simple and convenient savings bond program has to exist. At the moment, the winds are blowing the other way.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist.