For many advisors the ideal clients are those who are on the cusp of retirement and looking to eventually roll over a sizable sum built up in an at-work retirement plan.
A primary financial concern often held by clients in this situation is finding an investment that offers some ideal combination of yield, liquidity, and safety—at least for a portion of their assets.
It’s possible—as long as you’re willing to look beyond the normal roster of traditional investment vehicles and consider telling clients to buy United States Series I savings bonds right from the U.S. Treasury.
Not only does it arm them with certain tax benefits and protections against inflation, suggesting they invest in these savings vehicles can enhance your credibility and trustworthiness.
How they work
There are two types of savings bonds issued to new investors by the Department of the Treasury. Series E bonds pay a fixed rate over the bond’s 30-year term—currently an uninteresting 0.6 percent per year.
Series I savings bonds pay a yield that is tied to the Consumer Price Index, and can be adjusted up or down every May 1 and Nov. 1 over the 30-year life of the bonds. (More on that later.) The annualized yield announced on May 1, 2012 was 2.2 percent for the ensuing six months.
That rate is comparable to what is currently offered by a regular U.S. Treasury bond maturing in 20 years. It also beats the yield of Treasury Inflation Protected Securities (“TIPS”), and exceeds the payout of almost every certificate of deposit nationwide, regardless of maturity.
Yes, in theory, the yield on Series I savings bonds can go as low as “zero.” But that’s the worst it can get, even if the CPI turns negative in the future.
The current yield of Series I savings bonds is even better than it appears, for two reasons. The first one is that as with regular U.S. Treasury securities, the interest paid on savings bonds is exempt from taxation at the state level.
Perhaps even more important, savings bond owners can choose when to declare the interest earned, and therefore determine when (and maybe how much) it will be taxed.
In other words, bond owners can choose to either declare and be taxed on the interest annually, or delay until the bonds are finally cashed in.
All other factors being equal, the ideal situation in which to exploit this flexibility is for soon-to-be retired clients to purchase savings bonds, and then delay declaring the interest while in a higher tax bracket than they will occupy in retirement.
When the client retires, and by definition is more likely to both need the money and be in a lower tax bracket, he can redeem the savings bonds and pay any associated tax on the accumulated interest.
If he still doesn’t need the proceeds in retirement and therefore doesn’t have to liquidate the bonds, the interest will be sheltered from taxation, much like assets held in a pre-tax retirement plan or tax-deferred annuity.
This feature could help prevent clients from unintentionally being boosted into a higher tax bracket and/or triggering the inclusion of Social Security benefits in their taxable income.
Getting the money out
Another attractive feature of Series I savings bonds is the relative lack of market risk. The primary potential for any loss occurs if the bond owners redeem the bonds before maturity.
Even then, the worst-case scenario isn’t too bad. It’s difficult to redeem the bonds within the first 12 months after deposit, unless the owner is experiencing a financial hardship.
After 12 months the bonds can be cashed in with a penalty of just three months’ worth of interest.
After five years, the bonds can be redeemed with no penalties at all. But remember, the owner could be liable for a larger tax bill if she has chosen to delay declaring the interest.
This unique redemption schedule means that the sooner your clients purchase savings bonds, the sooner they will be able to redeem the securities with little or no penalty.
How to buy them
Although you may suggest savings bonds to your clients, you can’t buy the bonds for them. Nor can they buy the bonds at a local bank or credit union, since as of Jan. 1, 2012, a cost-saving measure eliminated that option.
Clients have to visit www.treasurydirect.gov, open an account, and supply a routing number for funds to be transferred from their checking or savings account to the Treasury Department.
Minimum purchase amount is $25, and the maximum per year is $10,000 for an individual. Couples could buy $20,000 per year.
How to buy more of them
There is a little-known way that savings bond buyers can not only exceed the $10,000 annual limit on purchases, but also—if it is of importance—get a paper version of the security.
The clients first need to have enough income withheld for federal income taxes during the year so they will qualify for a refund once the actual taxes are filed.
They can use any or all of their refund to purchase an additional savings bond, in multiples of $50 and for a total of no more than $5,000.
Once the clients complete their income tax returns and determine that they will receive a refund from Uncle Sam, they should include IRS Form 8888 (“Allocation of Refund”) with their returns.
Doing the right thing
Used strategically, clients can benefit from the Series I savings bonds. They’ll also appreciate your willingness to recommend an investment that pays you no fees or commissions.
True, you could lose several thousand dollars of assets each year for each household that follows this suggestion. But if that figure greatly affects your overall assets under management, you have much bigger issues about which you should be concerned.