Dear Dr. Don,
What was the rationale in reducing the Series I Bond limit from $30,000 per year to $10,000 per year? Is there any effort to return to the $30,000 limit?
— Vic Tim

Dear Vic,
I’m a little bit of a conspiracy nut on this topic, thinking the government put these limits in place because savings bonds were giving small investors an edge that they could exploit by investing in savings bonds. Also, a few months after the government put the savings bond limits in place, they started selling marketable U.S. Treasury securities in the TreasuryDirect program. The reduced minimum face value is $100 versus the prior minimum face value of $1,000.

A Series EE savings bond by law has to double in value over a 20-year holding period. That works out to about a 3.52 percent yield in an interest rate environment where the marketable 30-year U.S. Treasury bond is yielding 3.22 percent. The Treasury is currently paying a 1.1 percent yield on its Series EE savings bonds. Investors in these bonds get an additional, or catch-up, interest payment at the 20-year mark. But if you cash in before then, it’s your loss.

The Series I savings bonds earn interest in two ways. They earn a fixed component, which for current purchases is set at zero percent for the life of the bond. They also earn a variable component, which changes every six months and is tied to the annualized rate of inflation as measured by the Consumer Price Index. The current annualized inflation component is 4.6 percent. Combine that with the fact that savings bonds allow you to defer the income tax on the interest earnings until the bonds are redeemed or mature. Marketable U.S. Treasury securities don’t give you that option, and Treasury inflation-protected securities, or TIPS, have you pay income tax on the inflation component in the year it is credited to the security, not when you receive the money at redemption or maturity.

The government would like you to consider investing in U.S. Treasury marketable securities instead of savings bonds. The problem with the small denomination Treasury bills, notes and bonds is that, while they are easy to buy using TreasuryDirect, selling them prior to maturity can be an expensive proposition. You have to transfer the securities out of your TreasuryDirect account into a brokerage account and then pay the broker to sell the securities.

I don’t see the U.S. government reinstating higher savings bonds purchase limits anytime soon. It is able to sell all the marketable securities it needs at rates that are for the most part lower than what they pay investors to invest in savings bonds.

Under the new limits, an individual can buy a maximum of $5,000 worth of electronic and physical, or paper, bonds of each series in a single calendar year. So you can buy $10,000 worth of Series I savings bonds this year, until they stop selling physical bonds on Dec. 31, 2011.

If you want to invest in inflation-adjusted securities over and above the limit placed on your Series I savings bond purchases, you need to look at the TIPS market either by investing in the marketable securities outright or investing in a mutual fund that owns the inflation-protected securities.

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