Mel Lindauer

Savings Bonds Program Dying a Slow but Seemingly Certain Death


With the July 13, 2011 Treasury announcement that paper Savings Bonds would no longer be sold by banks and savings and loans or via mail after December 31, 2011, Treasury put yet another nail in the coffin of the US Savings Bond program. Starting in 2012, Savings Bonds will only be available via TreasuryDirect, the Treasury’s cumbersome and highly unpopular online web site. USA Today reported that during a recent nine month period, only 11% of the Savings Bonds sold were purchased via this unpopular online method, with the overwhelming majority (89%) being paper purchases. And many of that small minority who did use TreasuryDirect only did so in order to purchase additional Savings Bonds after they’d reached their paper Savings Bond limit.

Now Treasury wants to play “Father knows best” and hopes to force consumers to use a purchase method they’ve overwhelmingly rejected. When one looks at the recent history of changes Treasury has made to the Savings Bond program, it appears that it’s only a matter of time before they eventually do away with the program entirely. Let’s look at some of the reasons for that statement. HISTORY OF CHANGESEE Bonds Prior to 2005, EE Bonds earned a variable market-based rate of return which was lower than the comparable Treasury issue(s) they were tied to. For example, some EE Bonds earned 85% of the five-year Treasury note. So the Treasury has paid, and continues to pay, a reduced rate to the Savings Bond holders, and that’s a plus for the Treasury, since it means lower borrowing costs. Then, in 2005, Treasury changed the EE bond interest rate from a market-based rate to a fixed rate which is arbitrarily set by the Treasury, rather than market forces. That fixed rate is currently 1.1%, and has been as low as 0.6% as recently as April 2011. These EE Bonds are guaranteed to double in 20 years, which means investors might be able to earn ~3.5%, provided they hold their Savings Bonds for the full 20 years. However, if we compare that rate to 20-year bonds, which have a current yield of ~3.75%, we see that the 1.1% EE Bonds are a good deal for the Treasury, and that still holds true, even if they’re held for 20 years. Again, lower borrowing costs for the Treasury. I Bonds I Bonds (the “I stands for inflation) were introduced in 1998 with a fixed interest rate of 3.4%. This rate was (and currently is) arbitrarily set by the Treasury, not market forces. The Treasury has steadily lowered the I Bond’s fixed rate to 0%. Apparently expecting a low inflation environment, the Treasury thought they could lower borrowing costs by guaranteeing investors a real return (yield less inflation) since lenders would accept a lower rate in exchange for a guaranteed real return. However, since they don’t control the inflation adjustment part of the I Bond composite yield (the fixed rate plus the inflation adjustment), the current composite rate of those 0% I Bonds is 4.6%, all of which comes from the inflation adjustment side. Again, when compared to the Savings Bond market-based counterpart (Treasury Inflation Protected Securities, commonly called TIPS), which also provided a guaranteed real return, I Bonds historically provided the Treasury with lower borrowing costs. Now, with the huge budget deficits, the ballooning national debt, the Fed printing money, and inflation rearing its ugly head again, Treasury may well be having second thoughts about providing guaranteed inflation protection, and that could put I Bonds in jeopardy. HH Bonds HH Savings Bonds were previously purchased by investors who wanted current income. Unlike most other Savings Bonds which accumulate the interest tax-deferred until redemption, HH Bonds were used by investors who wanted current income. They were especially popular with retirees who could trade in their EE Bonds for the HH bonds, thus extending their tax deferral. The HH Bond interest, which was paid every six months, was taxable, but only at the Federal level. I say “were”, since as of September 1, 2004, HH Bonds were no longer available for purchase because Treasury eliminated the HH Bond program. Payroll Savings Program For years, investors purchased paper Savings Bonds using the automatic Payroll Savings Plan at their place of employment. However, Treasury eliminated that option as of December 31, 2010. Purchase Limit Changes Treasury severely reduced Savings Bond purchase limits from $30,000 for each type and method to $5,000, effective January 1, 2008. And with this July, 2011 announcement, the purchase limit has been halved again. Bogus Argument: At the time of the 2008 purchase limit change, Treasury claimed the reason for the reduction in purchase limits was because the Savings Bond program was intended for small savers with limited means.  Duh! Who set the limit to $30,000 for each type in the first place? Treasury itself did, of course. To then turn around and claim that the program was meant for small savers just doesn’t hold water, since small investors could always purchase as much as they could afford, up to the previous $30,000 limit. And what’s easier for the “small investor”? Buying their Savings Bonds at their local bank or setting up an account and navigating the TreasuryDirect maze? And what about those “small investors” who don’t have internet access, or who don’t feel comfortable making financial transactions online? And for retired investors, this may well be the only tax-deferred investment still available to them, since, with no income, they can no longer contribute to their IRAs or retirement plans. When trying to justify this reduction in annual purchase limits, Treasury claimed that many investors never reached their annual purchase limits. Duh! When a parent, grandparent or other friend or relative purchases a Savings Bond as a gift for a child, they’re highly unlikely to purchase $30,000 (or even $5,000), and yet Treasury used those purchases as “proof” that many investors (the children) never reached their annual purchase limit. Finally, if the Savings Bond program was intended for “small investors”, why did Treasury take away one of the small investor’s few available risk-free income options by killing off the HH Bond program that provided a steady source of predictable income for retired seniors? Investor Reaction The reception of the news has been overwhelmingly negative in the Bogleheads community as witnessed by this thread. Even investors who currently use TreasuryDirect, such as Bogleheads Ed and Patti Rager, aren’t pleased with the purchase limit change. When asked for their thoughts on the Treasury announcement, their response was similar to that of many other Bogleheads. “We're disappointed that the Treasury Department has decided to cut the annual amount of I Bonds that we can purchase in half, starting January 1, 2012. As retirees, we use the I Bonds as a safe reliable way to shift taxes into future years.  We wonder if the Treasury Department's real objective is to ultimately eliminate the only tax-deferred vehicle they offer to small investors in order to increase tax revenues.” Effect of Purchase Limit Reduction In 2003, Treasury sold $11.3 billion in Savings Bonds. By 2010, sales of Savings Bonds had dropped by 80% to just $2.3 billion. Needless to say, the reduction in purchase limits had a profound impact on the sales of Savings Bonds, which, as we pointed out earlier, were providing Treasury with lower-than-market borrowing costs. Talk about shooting one’s self in the foot! Treasury’s “Bogus” Justification While Treasury claims that eliminating paper Savings Bonds is a money-saving move, again this simply doesn’t hold water. First, since Savings Bonds have historically provided lower-than-market rates, Treasury’s cost of borrowing will be increased. Not only have the recent purchase limits been cut in half, the loss is likely be even greater, since many (most?) of the current paper-only Savings Bonds purchasers will not switch over to TreasuryDirect, a purchase method that they’re resoundingly rejected in the past. And, even those who do currently use TreasuryDirect will see their purchase limits cut in half. So borrowing costs will increase as a result of the lower Savings Bond sales volume. Secondly, while the Pittsburgh Federal Reserve announced that they’d lay off 200 employees who currently process paper Savings Bonds, they also stated that they’ll try to find other positions for these folks. TRANSLATION: “While we’re using this layoff announcement as part of the justification for the alleged cost savings, we’ll probably just move these employees over to the Bureau of the Public Debt where they’ll work answering questions from all the confused new TreasuryDirect investors and those who are locked out of their online accounts.” Anyone who’s taken even a basic management course understands that unit labor costs increase dramatically when you have approximately the same number of employees (or possibly even more) handling drastically reduced sales. Finally, Treasury claimed they’d save money on the printing, processing and mailing of the paper I Bonds, but they (purposely?) failed to mention the increased costs of printing, processing and mailing of the matrix that’s part of the TreasuryDirect login process. Back Door via IRS Refund At the present time, the only way investors will be able to obtain paper I Bonds after December 31, 2011 is via an IRS tax refund . Taxpayers can take part or all of their tax refund in paper I Bonds using IRS Form 8888 . While this program wasn’t eliminated in the Treasury’s announcement, that “back door” method of purchasing I Bonds may well be closed soon. It’s my guess that it may not last longer than one tax season, if that long. Death by 1000 Paper Cuts Eventually, Treasury will likely use the self-inflicted reduced sales figures to announce that “There’s little interest in Savings Bonds” and that the program is no longer cost-effective. They’ll then use that to justify ending the program entirely. The writing’s on the wall.  Mel Lindauer, CFS, WMS is one of the founders of the Bogleheads community and co-author of The Bogleheads’ Guide to Investing along with Taylor Larimore and Michael LeBoeuf. He is also co-author of The Bogleheads’ Guide to Retirement Planning along with Taylor Larimore, Richard Ferri, and Laura Dogu.