Disadvantages of Owning Savings Bonds

Savings bonds won't help much if you have a large amount to invest, say from an inheritance or the sale of a house. The Treasury limits the purchase of electronic EE or I bonds to $10,000 of each series per Social Security number every year. You can also buy up to $5,000 worth of paper I bonds for each taxpayer number with your federal income tax refund. You can't buy paper bonds at a bank any more, and paper EE bonds are no longer available at all.

Although you can cash electronic EE or I bonds online at TreasuryDirect, you have to wait until they are at least one year old. If you want the money before five years, the Treasury dings you with a three-month interest penalty. Many similar investments don't have these disadvantages, such as money market accounts, or certificates of deposit for under five years.

Savings bonds sometimes return low rates of interest compared to other investments. Series EE bonds dated later than May 2005 pay a fixed rate for 20 years, even if market rates increase. At 20 years, the Treasury adds extra interest if the bonds haven't doubled in value, and they continue to earn for 10 more years. I bonds earn a fixed interest rate that's determined when you buy them, plus a variable rate for inflation. If you buy when the fixed rate is low or zero percent, it stays the same for 30 years, or until you sell. The inflation component can also go to zero percent, and even the total rate sometimes falls to zero.

You have to cash EE and I bonds to get the interest, so they will not provide regular income as an investment. The interest on EE and I bonds is also subject to federal income taxes unless you use the proceeds for qualifying educational expenses. You can choose whether to claim the interest each year or wait until you cash the bonds, but you'll have to pay eventually. The interest is also subject to inheritance taxes, gift taxes and estate taxes at both the state and federal level, but it's not subject to state income tax.