6/6/2011 2:19 PM ET|By SmartMoney
Article from MSN.Money.Com
Staid old savings bonds have a brand-new appeal for investors weary of distressingly low interest rates. Here's why you might want to give them a second look.
You might think savings bonds are boring, but lately they're looking pretty good compared with other fixed-income assets, especially once you factor in their tax advantages.
Inflation-protected and tax-favored
Series I bonds are inflation-adjusted siblings of the more familiar Series EE bonds. Series I bonds earn interest for up to 30 years or until redemption, whichever comes first, and they receive favorable tax treatment.
You don't owe the Internal Revenue Service anything for the accrued interest until the year the Series I bonds mature or you cash them in. So you can defer the federal income tax hit for up to 30 years.
Alternatively, you can choose to report the accrued interest income on your tax return each year, which makes sense for kids and others who pay a very low or zero tax rate.
As a bonus, Series I bond interest is exempt from state and local income taxes.
Series I bonds are intended for very small investors. You can buy paper bonds at face value in denominations of $50, $75, $100, $200, $500, $1,000 or $5,000. Or you can buy them in electronic form with a minimum $25 investment.
The maximum amount of paper Series I bonds you can buy for yourself is limited to $5,000 annually. But you can buy up to another $5,000 worth of electronic bonds each year. If you're married, the same annual limits apply to your spouse.
You can also buy up to $5,000 of paper Series I bonds and up to another $5,000 of electronic bonds annually for another individual, such as a grandchild.
You can redeem Series I bonds for cash any time 12 months or more after the purchase date. However, if you redeem them within five years, you'll be charged a penalty equal to three months' worth of interest.
Here's where the inflation protection comes in: A Series I bond's interest rate consists of both a fixed rate that's determined upon issuance and that applies for the 30-year life of the bond, and a variable rate based on the inflation rate, which is reset twice a year.
For Series I bonds issued between May 1 and Oct. 31, the fixed rate is 0% (darned near what most certificates of deposits are paying). The current six-month variable rate, which will be reset Nov. 1, is 2.3%.
The fixed rate is combined with the current variable rate to determine the overall Series I bond interest rate that will be paid for each six-month period. Interest accrues monthly and compounds every six months. Because the fixed rate for Series I bonds issued between May 1 and Oct. 31 is 0%, the current overall rate equates to 4.6% annually.
Series EE bonds are tax-favored
Unlike Series I bonds, the more-familiar Series EE bonds are not inflation-adjusted. As with Series I bonds, they earn interest for up to 30 years or until redemption, and the interest income receives the same favorable tax treatment.
You can buy paper Series EE bonds for half of face value in denominations of $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000.
For example, you would pay $500 for a paper Series EE bond with a $1,000 face value. Alternatively, you can buy Series EE bonds in electronic form for face value with a minimum $25 investment. Series EE bonds are subject to the same annual purchase limits as Series I bonds.
Series EE bonds issued between May 1 and Oct. 31 earn a fixed annual interest rate of 1.1% for up to 30 years. However, if you hold them for 20 years, the government pays you enough extra interest to guarantee that you'll double your money, which equates to an annual interest rate of 3.53% over the 20-year period. But you have to hang in there for the full 20 years to collect on the double-your-money guarantee.
Like Series I bonds, you can redeem Series EE bonds for cash any time 12 months or more after the purchase date. However, if you redeem them within five years, you'll be charged a penalty equal to three months' worth of interest.
Savings bonds redeemed to pay college expenses can be tax-free
The accumulated interest on Series I bonds and Series EE bonds redeemed to pay college tuition and fees can be free of federal income tax.
This tax-saving deal is phased out for adjusted gross incomes between $71,100 and $86,100 if you're unmarried. For married joint filers, the phase-out range is $106,650 to $136,650. You must have been at least 24 years old when you bought the savings bonds to be eligible for this break.
Article from MSN.Money.Com