The Best Savings Account Isn’t At Your Bank

Your bank or broker can’t compete with this, so you probably haven’t been told about it.

Today we’ll talk about the Series I Savings Bonds from the US Treasury. Even if you think you know bonds and savings bonds bore you, keep reading. These have special features that most people don’t know about.

They pay a rate of interest far higher than you can get with a certificate of deposit or a savings account. The interest is tax-deferred, meaning you won’t pay tax until you redeem your bonds. A few months ago, they paid 2.76% but today they are paying 1.96% because inflation decreased. As of today, you would have to stretch out to a 60 month CD to beat that, and no savings account even comes close.

Pros

  1. Guaranteed principal – You will not lose money. If you buy a traditional bond on the open market, the price of the bond can go up or down. These savings bonds never go down. Their value only goes up based on interest accrual.
  2. Inflation protected – A component of the interest rate fluctuates based on inflation. If inflation goes up, the interest on your bond goes up. If inflation goes down, the interest of the bond will go down. This rate change happens every six months.
  3. Tax-deferred – You pay no tax on your interest until you cash in. With a savings account or CD, you state and local income tax every year.
  4. Tax-free Education Savings – While a 529 or Coverdell ESA are probably a better choice for education savings, one benefit of the I Bond is that if you redeem it to spend for qualified education expenses, you will not pay income tax on the interest.
  5. No local income tax – I Bonds are exempt from local income tax.
  6. $25 Minimum – The only CDs or savings accounts that can come close to this usually have a higher minimum deposit. With a $25 minimum, anyone can start building up their savings
  7. No Fees

Cons

There are some restrictions, but mostly not a big deal.

  1. $10,000 per year limit – You can only buy $10,000 per year. A married couple could do $20,000. You can gift $10,000 per child. This is per year, so one person after two years could have $20,000, and so on.
  2. Minimum 1-year hold – Your money is tied up for one year. Most CDs let you redeem early with a penalty. In the case of these bonds, you really can’t. Your money is the US government’s for one year.
  3. 5-year maturity – After one year, you can get your money back. If you cash in before 5 years, you forego three months of interest, similar to most CDs. Not really a drawback compared to the competition (CDs) but relevant.
  4. Old website – Let’s face it, http://www.treasurydirect.gov appears to be made in 1997.

I suspect without those limits, few would want to use a savings account at a regular bank.

Why haven’t you heard about this?

The US Treasury doesn’t pay commissions to brokers, bankers, financial advisors, etc. They don’t offer affiliate links to blogs like this. There is no incentive to sell this other than if someone is just looking out for your best interest, such as a fee-only financial advisor with a fiduciary responsibility or a friend like me.

The Bottom Line

I think these are a great option for a savings account or an emergency fund. Keep in mind that you can’t touch it for one year. So make sure you have some other accessible funds before you move your whole emergency fund to it. If you have had six+ months of expenses sitting around languishing in a savings account that doesn’t even keep up with inflation, you should really consider moving at least a portion to I Bonds.

Given the zero trading risk – you can’t lose money – but you earn tax-deferred interest comparable to 7-30 year AAA bonds (2.76% not long ago, 1.96% today), this really is a sweetheart deal. That’s probably why they limit you to $10,000 per year.

3 Replies to “The Best Savings Account Isn’t At Your Bank”

  1. Great info! Question: are there any guarantee assocations or other financial protections on this product in case of catastrophe? I assume FDIC isn’t involved since it’s not a bank.

    Like

    1. In this case you are lending money directly to the Federal Government. It is backed by the full faith and credit of the United States. Treasury Direct is just the website people can use to buy and manage their savings bonds directly without going through a bank or other middle man.

      Like

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