Like bathing suits, investments range from daring to very conservative. The U.S. Treasury's savings bonds are at the conservative end of the scale. If they were a bathing suit, they'd be the Edwardian variety that provided total throat-to-ankle coverage. The bonds are backed by the U.S. Government, and can only fail to pay if the federal government goes broke. The Treasury stopped selling H/HH bonds in 1994, so if you have some in your IRA, they must be moved to another product such as an annuity when they reach maturity.
Imagine if, instead of approaching the bank for a loan, you could just hand them an IOU and say "I'll pay you back with interest in 10 years." That's essentially how bonds work. They're issued by government bodies, utilities and various other companies, and pay a set return after a given time, called the maturity date. The more reliable the issuer, the lower the return they must offer to sell the bonds. High-risk companies offer excellent returns on their bonds because the investor must gamble they'll be around to pay. U.S. Treasury bonds are low-interest, because they're considered unusually safe.
Savings Bonds in Your IRA
Most investors use their IRA or their 401k as a place to hold equity investments, such as stocks or mutual funds. However, in times of low interest, it makes sense to hold E-bonds or H-bonds in your IRA. If your bond pays five percent and inflation is running three percent, you're only gaining two percent on your investment. Paying taxes on the interest might negate your gains completely. So, if you're holding savings bonds as part of your portfolio, it might make sense to keep them in your IRA where they'll grow tax-free.
Rolling Your H-Bonds
This is especially important if you've been holding H- or HH-bonds in your portfolio. They pay out interest income every year, which is ordinarily taxable at your highest rate. If you withdraw them from your IRA, you'll pay all that tax in one year. The logical thing to do, then, is re-invest those funds at maturity into another investment product. These could include stocks or mutual funds, different types of bonds, or an annuity. All of these have their advantages, though annuities might be especially appealing to a conservative H-bond investor.
A Quick Annuity Primer
Annuities are a variation on traditional whole-life insurance policies, designed to generate income instead of a lump sum. You can purchase one each year as your H-bonds mature, or simply pay into the same annuity each year. You can begin drawing an income from your annuity any time after you stop contributing to it. Traditional fixed annuities simply pay you a guaranteed income for the rest of your days. However, you can make them more advantageous by purchasing a "joint and last survivor" annuity, which pays until a second individual dies. You can also structure annuities to pay out to a named beneficiary, avoiding probate and estate taxes.
- Jupiterimages/Photos.com/Getty Images
- A Secured Bond Vs. a Cash Bond
- What Is the Difference Between a Bond & a Letter of Credit?
- How U.S. Treasury Bonds Work
- How to Put Up a Bond Against a Lien
- Difference Between Series E Bonds & Series H Bonds
- The Advantages & Disadvantages of General-Obligation Bonds
- What Type of Bond Can You Not Cash Out?