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US Series I Savings Bonds: A Bad Idea for Your Tax Refund?

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Savings Bonds: Are They Worth It?

By: Matt Robinson

Finding out that you are owed a refund after filing your tax return is never something to be upset about. With a tough economy taking a toll on many families, getting a little extra cash in your pocket can go a long way.

Last year, to help Americans whose retirement accounts were hit hard during the recession, the IRS provided a way for taxpayers to use part or all of their tax refund to purchase US Series I Savings Bonds. This year, the IRS enhanced this option by providing taxpayers with the ability to make someone else the owner, co-owner or beneficiary of the savings bonds. This means, an individual or married couple filing jointly can give up to $5,000 in savings bonds to their children, nieces, nephews, friends and so forth (Form 8888). Any refund allocation to savings bonds must be in multiples of $50, with any remaining amount directly deposited into a checking, savings, IRA or other savings account, or simply sent to you as a check in the mail.

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A US Series I Savings bond is considered by many to be a conservative investment for several reasons. Here are some benefits:

Indexed for Inflation

With a US Series I Savings Bond, you are protected against inflation. That’s because the interest you accrue monthly (compounded semi-annually for 30 years) is based of a fixed rate and a variable semi-annual inflation rate adjusted in May and November. If you purchase bonds between November 2010 and April 2011, your variable rate is based on the Consumer Price Index (CPI) change from March 2010 through September 2010. If you are purchasing bonds between May 2011 and October 2011, your variable rate is based on the CPI change from September 2010 through March 2011.

Risk of Default Is Low

These bonds are backed by the full faith and credit of the United States. Therefore, the preservation of capital is guaranteed.

Exempt from Taxes

Savings bonds are exempt from state and local income taxes.

Many investors say that potential profits are lessened in exchange for principal security. Others will say that your principal is not really protected because the Consumer Price Index for all Urban Consumers is cooked. Moreover, I-bonds have a current fixed rate of 0 percent, so you may be able to do better elsewhere. Let’s break down these negative assertions:

Worst Fixed Rate

Right now, the fixed rate on a savings bond is 0 percent, and the variable annualized inflation rate is running at 0.74 percent. Since the price of a bond and its yield move in opposite directions, it is generally a good idea to buy bonds when interest rates are high, rather then when they are low. Since interest rates are bound to go up from here, right now is probably not the best time to invest in US Series I Savings Bonds if you are looking for an attractive return on investment.

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But They Protect Against Inflation

That depends on whether you trust the Consumer Price Index issued by the Bureau of Labor Statistics. Some argue that the CPI is manipulated. Its calculation has changed over the years and some believe it is understated to reduce interest costs the government has to pay on money borrowed. If you take a look at what the CPI would be today if it used methodologies from the 1980s and ’90s, as John Williams from shadowstats.com did, it’s pretty easy to see that the CPI is indeed understated today, to say the least. Other financial experts, like notable economist Peter Schiff, also assert that the CPI conceals inflation.

Ultimately, if you are looking for a great return on investment, or if you are looking for a hedge against inflation, Series I savings bonds are not a good option. However, if you are looking to preserve principal, to make sure your children’s college funds do not become a gamble in these volatile markets, a Series I Savings Bond may be the way to go.

Keep in mind there is a clear distinction between preserving your capital and preserving your purchasing power. If the CPI is understated (as many believe it is), then although you will preserve your principal, you may not be preserving your capital’s purchasing power. For example, if inflation is really running higher than the CPI, the money you invested in Series I Savings Bonds will not buy the same goods and services that your capital would have purchased if you spent it now, redeemed your bonds later or waited until bond maturity. In either event, it is always best to check with your financial advisor before making investment decisions.

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This article was provided by Matt Robinson, a personal finance blogger and accountant with a focus on taxes. He is also a contributor to the tax blog at TaxDebtHelp.com.

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US Series I Savings Bonds: A Bad Idea for Your Tax Refund? was originally featured on Quizzle Wire

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