The Is May Have It

June 5, 2002
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GRAND RAPIDS — At first glance, buying U.S. Savings Bonds as part of a retirement plan might seem like buying your father’s Oldsmobile. It’s not very sexy, and certainly not very cutting edge.

At second glimpse, however, including savings bonds in that retirement package might not be such a bad buy — especially if it’s the Series I, which has an interest rate of 6.49 percent. For sure, a return of that size likely won’t let anyone retire early. But assuredly it’s a better payback than those who invested thousands in dot.com and IT companies have gotten recently.

And because of the volatile dips in the stock market, investment managers have taken that second look at I Bonds and have made some fairly favorable comments.

“An investor putting $10,000 in an I Bond today can count on seeing its purchasing power grow in five years’ time to nearly $12,000. No fees. No current taxes. No interest-rate risk. No volatility,” said Robert Barker in Business Week.

“For taxable accounts, I like the Series I Savings Bond. You can buy them online or from your local bank. It has both a fixed and variable component in the interest rate. The variable component is based on the inflation rate,” said Dr. Don Taylor at TheStreet.com.

“This is a gift, an absolute gift,” said Eric Ericksen, an investment manager at 1345 Monroe NW who also teaches personal finance at Grand Valley State University.

The Series I Bonds are similar to the Series EE Bonds in some respects. Both are offered in eight denominations and both have the same cashing, life span and purchase limit. But the I Bond is issued at face value and is inflation adjusted. Twice each year the inflation rate is calculated from the CPI, at the same time when the bond’s fixed rate of return is announced.

The current fixed rate for the EE Series is 5.50 percent, while the I Bond is at 6.49 percent.

“It’s an absolute gift because it has the safety of the Treasury Bonds, plus it has tax deferral and it pays 30 percent more than a comparable bond. In other words, it’s paying 6.5 percent instead of five. And it’s inflation adjusted,” said Ericksen.

“As long as inflation stays in the 2 to 2½ percent range, you’re going to get that 6.5 percent. And, obviously, if it goes higher, you’re going to get even more,” he added.

Erickson pointed out that when an investor buys a certificate of deposit with, say, a return rate of 6 percent, that return gets lowered by the inflation rate. For instance, if inflation reaches 3 percent this year, an investor actually gets a 3 percent return on the 6 percent CD. In contrast, the I Bond adjusts for inflation.

“If inflation doubles, this (the I Bond) will go to 9 percent. This competes directly with the banks,” he said. “For the fixed-guaranteed money, up to $30,000 per person or $60,000 per couple, this is a far better alternative than CDs.”

An additional feature of the I Bond is that its earnings are exempt from state and local income taxes, while CD interest isn’t. As for federal taxes, these can be deferred for up to 30 years, or until redemption or other taxable disposition — whichever comes first. But if the earnings are used to pay for college tuition, instead of retirement, then the money is tax-free.

Ericksen said that investors who may be interested in buying I Bonds should buy these in smaller denominations. The purchase limit is $30,000, while the highest bond has a face value of $10,000. He said that an investor who wants to buy $30,000 worth of these bonds would be better off getting six $5,000 bonds instead of three $10,000 notes.

That’s because an investor may need to redeem part of that investment before retirement. If the bonds are in smaller denominations, there is more tax freedom in withdrawing funds, as taxes will only be applied to the bonds that are cashed in and not to the entire investment.

“That’s because there is no partial surrender,” he said.

So, all in all, maybe kicking the tires on your father’s Oldsmobile isn’t such a bad idea.

“Every retiree ought to have a diversified portfolio. That is certainly the message of the last 12 months, but it’s also been the message of the last 90 years,” said Ericksen.

“That diversified portfolio should be made up of the fixed-income type investments and equities. Instead of having money in CDs or money-market accounts, this is far superior.”

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