Net Gains: Is Grandma's Savings Bond a Dud?

May 14, 2008 — -- Whether by design or by accident, the trusty U.S. savings bond may be in its waning days.

Recent moves by the federal government encourage small investors to forego savings bonds and, instead, to purchase other types of U.S. Treasury securities.

The latest blow to what has been a gift of choice for generations of grandparents, aunts and uncles came May 1, when the U.S. Treasury announced new savings bonds rates. For purchases between May 1 and Oct. 31, the fixed rate on new Series EE bonds will earn a miserly 1.40 percent, while new Series I bonds will carry a 4.84-percent rate.

That 4.84 percent rate on Series I bonds sounds decent, but you might want to hold off until you hear the details behind that number.

Series I bonds, which are meant to keep pace with inflation, earn interest at a rate that is a combination of two parts. One part is an inflation-based rate that adjusts twice a year; the second one is a fixed rate that remains the same over the course of an I bond's 30-year life.

It was the fixed-rate portion of the new I bond rate that stunned savings bond fans. It is 0 percent, down from 1.2 percent in the previous six months.

That means any I bond you buy between now and October will earn nothing above and beyond the inflation rate. If inflation falls to zero, or if we enter a period of deflation, you would receive no interest payments on I bonds purchased during the current six-month spell.

The inflation-adjusted piece currently pays 4.84 percent based on recent numbers that capture a rise in consumer prices. The inflation adjustment could rise or fall when it is reset next on Nov. 1.

This is the first time in the I bond's history the fixed rate has paid nothing. The previous low had been 1.00 percent on I bonds purchased between May 1, 2004, and April 30, 2005.

One thing to keep in mind is that the fixed rates on I bonds bought before May 1 are unaffected by the new 0 percent rate. Depending on when they were bought, the fixed-rate portion could pay as high as 3.60 percent.