investing

Turn your tax refund into a savings bond?

Highlights
  • The move is part of President Barack Obama's recently announced initiatives.
  • The idea is that a rock solid investment has a place in all portfolios.
  • You must hold an I bond for 12 months before cashing it.

Buying inflation protection will be as easy as checking a box on your tax return in the 2010 tax season. The federal government is amending IRS Form 8888 to include U.S. savings bonds, specifically the Series I bond. IRS Form 8888 allows taxpayers to direct that their refunds be split to various accounts such as savings, checking, IRAs and education savings.

The move is part of President Barack Obama's recently announced initiatives for retirement savings. The idea is to give people who might not save ordinarily an easy way to build a nest egg by having their tax refund directed toward buying savings bonds.

It's an idea initially proposed by Harvard Business School professor Peter Tufano several years ago after studies showed that low-to-moderate-income, or LMI, families were willing to direct a portion of their tax refund to buying savings bonds.

Tufano and Doorways to Dreams Fund (D2D Fund), a Roxbury, Mass.-based organization co-founded by Tufano that seeks to expand financial services to low-income communities, did separate studies in concert with volunteer income-tax assistance sites, as well as H&R Block, that showed people responded favorably when asked by a tax preparer if they'd like part of their refund to go toward a savings bond.

"We found that a substantial fraction of LMI families were, in some sense, demotivated or discouraged about saving for themselves, but the old-fashioned impulse of saving for your kids still worked," says Tufano.

Tufano says approximately 70 percent of the savings bonds sold in the research were bought with children as co-owners.

"While saving for retirement might seem like a far off goal," Tufano notes, "trying to put a little money away for your kids seemed like something that parents, grandparents, aunts and uncles understood, but nobody had been asking them to do that for a long time."

Although the research focused solely on LMI wage earners, Timothy Flacke, executive director of D2D Fund, says it's reasonable to think that such an easy method for buying savings bonds also might appeal to other income groups.

"The events of the last year and a half have underscored the importance of diversification. The idea is that a rock solid investment has a place in everybody's portfolio and I think it would make sense for someone who is middle income."

The I bond is meant to protect your investment from inflation. During a prolonged period of low inflation, such as we're going through now, I bonds may not be especially attractive. The fixed rate is critical since it stays with the bond for its 30-year life. The current bond has a fixed rate of 0.10 percent. That means you'll get just 10 basis points above inflation on an annual basis as long as you own the bond. The adjustable inflation component changes every May and November.

Of course, people who decide to buy an I bond every year with their refund will end up with a variety of fixed rates, some of which no doubt will be considerably higher.

"Certainly, this is a terrible rate," says Tom Adams, founder of the Savings Bond Advisor Web site. "Historically, if you average out I bond rates, they're competitive. These rates reflect what's going on in the market."

The I bond/tax refund program will, undoubtedly, change for the better in future years. This year, for instance, co-ownership of bonds is not allowed -- you can't buy a bond in your name and your child's or grandchild's. That is expected to be allowed in the 2011 tax season. Also, the current program allows only for paper bonds; experts think electronic accounts may be offered in the future.

Here are some of the main features of the 2010 program:

  • Use IRS Form 8888 to direct that all or part of your federal tax refund go toward the purchase of an I bond.
  • Only paper bonds will be issued. Certificates will be mailed to you.
  • The I bond is a "face value" bond, meaning that if you pay $50 you'll get a $50 bond.
  • I bonds are available in denominations of $50, $100, $200, $500 and $1,000. If you buy $250 worth of bonds or less, you'll receive $50 bonds. If you buy more than $250 you'll receive five $50 bonds and the remainder in the largest denominations possible.
  • You are allowed to buy a maximum of $5,000 in paper bonds per Social Security number.
  • You must hold an I bond for 12 months before cashing it. Exceptions may be allowed in the event of certain emergencies. If you cash an I bond in fewer than five years you'll forfeit the last three months' accumulated interest.
  • Co-ownership of I bonds will not be allowed for the 2010 tax filing season. You can only buy a bond in your name or, if you're married and filing jointly, it will be in both spouses' names.

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