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Treasury Rewrites Series EE Savings Bonds Rules

Contributed by mm | April 5, 2005 5:18 PM PST

Yesterday, the Treasury Department announced one of the biggest changes to the Savings Bonds in recent memory. The change is specific to Series EE Savings Bonds, which, since 1982, has been earning an interest rate that is adjusted every six months and is pegged to 90% of the average 5-year treasury note yield in the prior 6 months. With this change, Series EE Savings Bonds issued after May 1, 2005 will bear a fixed rate for the lifetime of the Bonds up to 30 years.

Take a look at the announcement:

"Rates for new issues will be adjusted each May 1 and November 1, with each new rate effective for all bonds issued through the following six months. Interest accrues monthly and is compounded semiannually. Savings bonds must be held a minimum of one year, and there is a three-month interest penalty applied to bonds held less than five years from issue date. At a minimum, Treasury guarantees that a bond's value will double after 20 years, its original maturity, and it will continue to earn the fixed rate set at the time of issue unless a new rate or rate structure is announced. If a bond does not double in value as the result of applying the fixed rate for 20 years, the Treasury will make a one-time adjustment at original maturity to make up the difference."

Sp, how to make sense of the change?

First, the current floating-rate Series EE Saving Bonds yield 3.25%, a rate that was published in November 2004. The new rate for existing EE bonds will be issued next month, which, based on the 5-year treasury note yield trend in the last six month, I estimated the new rate will be 3.50%-3.65%. You might consider the current Series EE Savings Bonds as good as a money market account that always offers competitive rate. In the long run, I will expect it can pay a bit more than the best money market account around (like 3.25% from EmigrantDirect right now.) in exchange for limited liquidity in the first 12 months -- you cannot redeem Savings Bonds in the first 12 months.

The rate associated with the new fixed-rate-for-life Series EE Savings Bonds is a different story. According to the FAQ accompanying this change, "[t]he rate will be based on 10-year Treasury note yields and adjusted for features unique to savings bonds, such as the tax deferral feature and the option to redeem the savings bonds at any time after the initial holding period." Now that the 10-year treasury note is yielding 4.47%, I will bet the Series EE rate Treasury is going to announce for new issues will be 4.00%-4.20%.

Judging the different features, I will say the current floating-rate Series EE is the best buy for long-term investment. Series EE under the new rule seems to be a dog -- unless you want to take advantage of the tax-free-interest for education-related withdrawals and redeem in a year or two, your better bet may be to park your money at the top-yielding money market accounts.

By the way, if you are interested in Svaings Bonds, the best resource I found so far is Savings Bonds Alert. The 2-page Fact Sheet (PDF file) is a nice and easy way to learn the basics of Savings Bonds.

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