In these days of mutual funds, IRA’s, and 401k’s, bonds are all but forgotten. Not ready for 401k? Not into the stock market scene? Take heart! Bonds may be the option for you!
Employers used to offer Bonds as part of their standard payroll deduction programs, right along with the United Way. Every year a rep. would go to locals companies and give a short seminar on why people should buy bonds and the benefit of bonds to the purchaser.
Why should you buy bonds? They are an excellent investment. They are foolproof. I love to tell people “don’t worry, buy bonds! The only way you won’t get your money back is if the government collapses! And then you’ll have bigger worries!)
The Federal Government backs U.S. Bonds, or more correctly stated, the U.S. Treasury. Therefore, you are guaranteed to get your money back plus interest.
Bonds support the government. Money from bond purchases is used to pay off government debt. Purchasing bonds is a painless way to save. The smallest bond is the EE $25.00 bond. A mere $12.50 to purchase a $25.00 bond!
Who doesn’t have $12.50? Skip a movie! Skip a frappe’ latte’ or two, fewer movie rentals. Bonds can be redeemed without penalty after a year. If cashed before then, there is a 3-month penalty. (You loose three month’s of interest.)
There are two basic types of bonds: I Bonds and EE Bonds. I bonds have a fixed rate and mature in a specific period of time. The fixed rate allows calculation of the exact date the bond will mature. (Mature – reach maximum value). I bonds can be held up to 30 years. At maturity the bond can either be cashed, or rolled over into EE bonds.
Rolling the bond allows the holder to defer payment on the interest earned on the original bond. I Bonds are issued at maturity value. Interest earned on the bond is paid when the bond is cashed. The holder receives statements showing how much interested has been earned. Interest is calculated monthly and then compounded twice per year.
The other common bond is the EE Bond. The EE bond is also issued at maturity value. Unlike the I bond, (and this is what made them so popular), you only pay half the face value for the bond! A $50.00 bond costs $25.00! When the EE bond matures it will be worth $50.00. EE bonds accrue interest based on the market rate vs. the fixed rate.
Interest rates could be 6% one month, 6.5% one month, and 4.5% another, depending on current market rates. Thus, maturity dates vary on EE bonds. The bond will mature when enough interest is earned to bring the value of the bond up to face value, (in our example $25.00 in interest is needed).
Another bond, the HH, is no longer issued. HH bonds paid interest as it accrued monthly, rather than at maturity. The holder received a monthly check for the earned interest. HH already held can be redeemed or rolled at maturity.
Besides being a good investment, bonds reduce taxable income. Bond purchases are deducted from gross earnings, which reduces taxable income. And, you don’t pay taxes on the interest until you cash the bond! As long as you roll the bond at maturity instead of cashing it, the income is deferred.
Once the bond is cashed, you will receive a form 1099-INT. This form will show how much interest you earned on your bonds for the purposes of tax reporting. The Federal Tax Return guidelines give very good instruction on where and how to report this income on your return.
For the investor who wants a little more challenge, a faster pace, big dollar action; there is the big daddy of all the bonds: the T-Bill i.e., Treasury bond.
Treasury Bonds are a very special instrument. T-Bills are what the Federal Reserve uses to control the flow of money. To take money out of the economy they auction T-bills, (sell them). When they want to put money into the economy they buy them back, (call them). T-Bills are purchased in minimum denomination of $1,000, up to a maximum purchase of $5 million dollars! (I bonds and EE have a maximum of $30,000 each. The maximum you could hold at one time is $60,000).
I bonds and EE bonds can be purchased through your bank or credit union or online, at anytime. T-Bills are purchased through a broker or dealer, during weekly auction.
The term on T-Bills is 4, 12, or 26 weeks. T-Bills do not “accrue” (earn) interest like I and EE bonds. T-Bills are sold at a discount rate’ determined at auction. Let’s purchase one T-bill. The discount rate the week of our purchase $50.00. We would pay $950.00 for the T-Bill. At maturity or when it is called, we would get $1,000. (T-Bills are rarely held until maturity. They are “called in” usually after a few days or weeks).
Want more excitement? Try the other form of T-Bill, The Cash Management Bill!