Many people save for retirement using a traditional IRA or 401k. Both of these investment vehicles offer the benefit of tax deferral (until funds are withdrawn during retirement), enabling you to compound returns.
Another key feature of both these retirement accounts is flexibility in terms of investment options. You have the choice of investing in stocks, bonds and even funds that hold commodities such as gold. Savings Bonds don’t offer the investment flexibility of a 401k or IRA and there are only two investment options (EE bonds and I Bonds). However, these are two extremely safe investment options.
The Benefits Of Using Savings Bonds For Retirement
- Double Your Tax Deferred Contributions: Your 401k and IRA have annual contribution limits, currently under $20,000 per year. You can purchase up to $10,000 of EE Savings Bonds and $10,000 of I saving bonds per year, effectively doubling your tax deferred contributions each year.
- No State Or Local Taxes: Unlike an IRA or 401k, there are no state or local taxes on the interest that you earn when you cash-in a savings bond.
- No Age Related Withdrawal Penalties: If you cash a traditional IRA or 401k in before age 59 ½, in most cases there is a penalty. After 5 years, a savings bond can be cashed in with no penalties at all.
- Super Safe: U.S. Savings Bonds are backed by the full faith of the U.S. government.
The Drawbacks of Investing Using Savings Bonds
- No Investment Flexibility: If you want to change your investment choice, you will trigger a tax payment on interest earned. You cannot even switch between the two different types of saving bonds.
- Relatively Low Rate of Return: Compared to more risky investments, savings bonds offer a low rate of return, particularly if the economy does well.
What type of savings bonds should you buy?
If your time horizon for cashing in is less than 20 years, then I bonds are your best choice. EE bonds, if sold before maturity (20 years after purchase), are paying less than 1% interest. I Bonds are currently paying interest at the rate of inflation. Over the last five years, inflation has averaged a little over 2%. However, some well known figures believe that inflation could rise to 3, 4 or even 5% over the next few years. (You can find up to date savings bonds rates here)
If your time horizon is 20 years or longer, the question is more complicated. When held to maturity, EE savings bonds pay 3.5%. If you think that inflation over the next 30 years is going to be less than 3.5%, then EE bonds are the better choice. While historically inflation has averaged well below 3%, we are in interesting times. If you don’t have a strong notion of future inflation, I would suggest a mix of 50% EE and I Bonds.
What happens after the owner of the savings bonds dies?
If two people are listed as joint owners of the savings bond, the remaining owner can cash in the bonds. Savings bonds with one owner can have another individual listed as a beneficiary. The beneficiary will receive the savings bond in the case of the owner’s death. If the owner or owners of a savings bond is dead and there is no beneficiary, the saving bonds become the property of the estate. More information on this can be found at Death of A Savings Bond Owner.