‘Inflation-Indexed’ Series I Bonds Win Small Savers’ Favor

Buying U.S. savings bonds has, for years, been a safe and easy way for Americans to put money aside for their kids’ education, their retirement or family emergencies.

Savings bonds are available in denominations as small as $50 and are fully guaranteed by the federal government. In addition, buyers can defer paying taxes on their earnings until the bonds are redeemed or they mature.

Now there’s a new savings bond, the Series I Bond, which has exploded in popularity since its introduction in the fall of 1998. The “I” stands for “inflation-indexed,” and the earnings rate on the 30-year bond is a combination of a fixed rate that applies for the life of the bond plus an inflation “premium” that is adjusted twice a year.

I Bonds currently have a fixed interest rate of 3.60% and, with the inflation premium, are earning a total of 7.49%. Traditional Series EE bonds, by comparison, are paying 5.73%, and five-year certificates of deposit at banks are averaging under 6.7%.

Peter Hollenbach, spokesman for the Treasury Department’s Bureau of Public Debt, which oversees savings bond sales, says the I Bonds “are a great hedge for the small saver . . . [because] individuals can put the money away and not worry about what happens to inflation.”

Sales of I Bonds have risen from between $30 million to $40 million a month in late 1998 to about $200 million a month this year, Hollenbach said.

Daniel J. Pederson, author of “Savings Bonds: When to Hold, When to Fold and Everything In-Between,” suggests that people already investing in Series EE bonds should consider moving to I Bonds. I Bonds also are a good choice for people looking for an alternative to money market funds or certificates of deposit, he said.

“I think the I Bond will outperform the EE going forward,” Pederson said. “A rate of 3.6% over inflation for the life of the I Bond is an attractive guarantee. Other instruments average 1% to 2.5% over inflation.”

An added benefit is tax deferral, and “you have total control of when to trigger the taxable event,” Pederson said.

I Bonds, like Series EE bonds, are designed as long-term investments. You have to hold them for at least six months and, if you redeem them before you’ve held them for five years, there’s a three-month interest penalty. After that, you can redeem them when you want. You’ll pay only federal taxes on the earnings, because savings bonds are exempt from state and local taxes.

Workers can wait until retirement to cash in savings bonds, when presumably they’ll be in a lower tax bracket. Or families that meet certain income requirements--currently a maximum of $81,100 in adjusted gross income--can avoid or reduce taxes on their bond earnings if they’re cashed in to cover education costs.

I Bonds, like Series EE, are available in denominations of $50; $75; $100; $200; $500; $1,000; $5,000 and $10,000.

Company-sponsored payroll savings plans are still a popular way to buy bonds, or the bonds can be purchased at most banks, credit unions and other savings institutions.

You can also go online and buy direct at the U.S. Treasury’s site.

I Bonds should not be confused with the inflation-indexed securities sold by the Treasury, which are quite different.

These securities--also known among brokers as TIPS, for Treasury inflation-protected securities--require a minimum $1,000 investment.

They’re auctioned several times a year, most recently with an interest rate of 4.25% and yield of 4.338%. Semiannual interest payments are taxable.