So far in this group of posts on savings bonds we have covered the now defunct Series E bonds, the basics of Series EE Bonds, the basics of Series I Bonds and how to buy and sell savings bonds. Today we’ll compare Series EE savings bonds with Certificates of Deposit (CDs) and Treasury bills and notes.
Default Risk: Because Series EE savings bonds are issued by the Federal Government the risk of default is almost nonexistent (and if the Federal Government does default we’ve got a lot more problems than our savings bond holdings). CDs are insured by the FDIC up to specified limits, so as long as you stay under those limits, your CDs are insured by the Federal Government as well. Since the Federal Government issues Treasury bills and notes, they have the same risk of default.
Risk of Decreased Value Prior to Maturity: The value of savings bonds is monotonically increasing (i.e. it never decreases, although it may stay constant for a period of time). Savings bonds accumulate and compound interest. You get the interest when you cash the bond in. If you cash in a savings bond before maturity, you get its accumulated interest less any prepayment penalties. Remember, you cannot cash savings bonds in for the first year.
Some CDs allow you to reinvest the interest in the CD (the same as a savings bond); the rest pay out interest as it is earned. CDs typically pay out interest either monthly, quarterly or semi-annually. The value of a CD at maturity will equal its face value plus accrued interest. However, if you need to cash out a CD before its maturity, its value is subject to fluctuation.
Some CDs have prepayment penalties similar to those for savings bonds. For those, you receive the full value of your CD plus accumulated interest less the prepayment penalty. Other CDs, however, do not allow for prepayment except in the case of death, where a put option allows your estate to sell the CD back to the bank at full face value. To convert the CD to cash prior to maturity, you will have to sell the CD on the open market. If interest rates have risen since you bought the CD, its value will have fallen and you will suffer a loss. Conversely, if interest rates have declined, you may receive more than the face value of the CD. Regardless, if you must turn to the open market, you will have to pay a brokerage commission to sell your CD.
Treasury bills and notes generally pay interest twice a year. At maturity they pay their face value. If you need to sell them prior to maturity, you will be subject to market risk. As with CDs if interest rates have increased, you will sell at a loss. If interest rates have decreased you will sell with a gain. There is a large secondary market in Treasuries, but you will have to pay broker costs to sell.
Call Protection: Savings bonds are noncallable. You can decide when to cash them in; the government cannot force you to surrender them earlier than you wish. Some CDs are callable, which means if interest rates decline the issuer can force you to sell the CD back to them at a time when any reinvestment will be at lower interest rates.
Treasury securities are noncallable.
Interest Accrual Period: Savings bonds continue to accrue interest for 30 years. CDs and Treasuries stop earning interest after maturity, which for Treasuries can be up to 30 years. Most CDs have much shorter maturities, although you can usually find CDs with maturities of up to 20 years.
Taxation: Savings bonds interest earnings are not taxable by state and local governments, nor are interest earnings on Treasury securities. CD interest is, however, taxable by state and local governments. All three instruments are taxed by the Federal Government.
Under certain situations the proceeds from the sale of savings bonds can be applied to qualified educational expenses and be exempt from federal income taxes. No such benefit exists for CDs or Treasuries.
Ease of Purchase: CDs can be purchased directly from most financial institutions or online through TreasuryDirect®. Newly issued Treasury bills and notes can also be purchased through TreasuryDirect®. You can also purchase Treasuries through a broker.
Transaction Fees: There are no transaction fees to purchase or redeem savings bonds. If you buy Treasuries at auction through TreasuryDirect® there are no purchase fees. Similarly, if you purchase a newly issued CD, the bank picks up any transaction costs. If your Treasury or CD matures, there should be no transaction fee to surrender your security. However, if you sell either a CD or Treasury before its maturity, you will be subject to broker fees.
Amount of Purchase: The maximum annual purchase for each kind of savings bond (Series EE or Series I; paper or electronic) is $5,000. There are no maximum amounts for CDs or Treasuries. (Although to retain the FDIC guarantee for all of your CDs, you must keep the value of your CDs at any particular institution below the insurance limit.)
All that remains to discuss the rate of return on Series EE bonds when compared to CDs and Treasuries and the effect of taxation on the rate of return, which we’ll save for the next post.