Savings Bonds for the Holidays?

Interest rates are rising, but savings bonds are missing the party. In October, a newly issued series EE bond offered a limp 0.1%, the same rate new bonds have carried since November 2015. The composite rate on a new I bond was 2.52%.

If you want to buy a savings bond as a gift for a young child, the EE bond may actually be a better choice. If accumulated interest doesn’t double the value of an EE bond you buy today after 20 years, the Treasury will adjust the bond’s value to twice the purchase price at the 20-year mark, for a guaranteed return of about 3.5%.

How they work. EE bonds carry a fixed rate, which the Treasury Department resets for new bonds every May 1 and November 1 (after our press date for this issue). Ken Tumin, of DepositAccounts.com, predicted that the EE bond rate would remain flat at 0.1% with the November 1 adjustment. Federal income tax on interest from EE and I bonds can be deferred until you redeem the bond or it matures. (Interest is not subject to state or local tax.) An I bond’s composite rate includes a fixed rate and an inflation rate that adjusts semiannually. Tumin predicted a composite rate of 2.72% on new I bonds starting November 1.

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If you want your gift to go toward college costs, savings bonds aren’t the best choice. All or a portion of the interest earned with EE and I bonds may be tax-free if used for qualified education expenses, such as tuition and fees. But among other limitations, including income caps, the bondholder must have been at least 24 years old on the first day of the month in which the bond was purchased to qualify for the tax break when redeeming it—so a child who receives a bond in his or her own name won’t benefit.

Instead, consider contributing to a child’s 529 college-savings plan, which “is likely to have a better outcome over a 20-year period than buying a savings bond today,” says Jill Fopiano, CEO of Boston wealth-management firm O’Brien Wealth Partners.