Turn your tax refund into a savings bond

By Bankrate.com

Buying inflation protection will be as easy as checking a box on your tax return in the 2010 tax season.

The Internal Revenue Service is amending Form 8888 to include U.S. savings bonds, specifically the Series I bond. The form allows taxpayers to direct that their refunds be split to various accounts such as savings, checking, IRAs and education savings.

The move is part of President Barack Obama's recently announced initiatives for retirement savings. The idea is to give people who might not ordinarily save an easy way to build a nest egg by having their tax refunds directed toward buying savings bonds.

Doing it for the kids

It's an idea initially proposed by Harvard Business School professor Peter Tufano several years ago after studies showed that low- and moderate-income families were willing to direct a portion of their tax refunds to buying savings bonds.

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Tufano and the Doorways to Dreams Fund, a Roxbury, Mass., organization co-founded by Tufano that seeks to expand financial services to low-income communities, did separate studies in concert with volunteer income tax assistance sites, as well as H&R Block, that showed people responded favorably when asked by a tax preparer if they'd like part of their refund to go toward a savings bond.

"We found that a substantial fraction of LMI (low- and moderate-income) families were, in some sense, demotivated or discouraged about saving for themselves, but the old-fashioned impulse of saving for your kids still worked," Tufano says.

What you'll earn

He says approximately 70% of the savings bonds sold in the research were bought with children as co-owners.

"While saving for retirement might seem like a far off goal," Tufano notes, "trying to put a little money away for your kids seemed like something that parents, grandparents, aunts and uncles understood, but nobody had been asking them to do that for a long time."

Although the research focused solely on low- and moderate-wage earners, Timothy Flacke, the executive director of the Doorways to Dreams Fund, says it's reasonable to think that such an easy method for buying savings bonds might appeal to other income groups, too.

"The events of the last year and a half have underscored the importance of diversification," he says. "The idea is that a rock solid investment has a place in everybody's portfolio, and I think it would make sense for someone who is middle income." The I bond is meant to protect your investment from inflation. During a prolonged period of low inflation, such as we're going through now, I bonds may not be especially attractive.

The earnings rate for I bonds is a combination of the fixed rate and the inflation rate. The fixed rate is critical because it stays with the bond for its 30-year life. The current bond has a fixed rate of 0.3%. That means you'll get just 30 basis points above inflation on an annual basis as long as you own the bond.

The adjustable inflation component changes every May and November. The current 3.06% rate of inflation (as measured by the Consumer Price Index for All Urban Consumers) will apply for the bonds' first six months after issue. So the annualized earning rate for I bonds bought from November 2009 through April 2010 is 3.36%.

Of course, people who decide to buy an I bond every year with their refund will end up with a variety of fixed rates, some of which no doubt will be considerably higher.

"Certainly, this is a terrible rate," says Tom Adams, the founder of the Savings Bond Advisor Web site. "Historically, if you average out I bond rates, they're competitive. These rates reflect what's going on in the market."

Look for future improvements

The I bond/tax refund program is likely to change for the better in future years. This year, for instance, you can't buy a bond in both your name and your child's or grandchild's. That is expected to be allowed in the 2011 tax season. Also, the current program allows only for paper bonds; experts think electronic accounts may be offered in the future.

Here are some of the main features of the 2010 program:

• Use IRS Form 8888 to direct that all or part of your federal tax refund go toward the purchase of an I bond.
• Only paper bonds will be issued. Certificates will be mailed to you.
• The I bond is a "face value" bond, meaning that if you pay $50 you'll get a $50 bond.
  

• I bonds are available in denominations of $50, $100, $200, $500 and $1,000. If you buy $250 worth of bonds or less, you'll receive $50 bonds. If you buy more than $250 you'll receive five $50 bonds and the remainder in the largest denominations possible.
• You are allowed to buy a maximum of $5,000 in paper bonds per Social Security number.
• You must hold an I bond for 12 months before cashing it. Exceptions may be allowed in the event of certain emergencies. If you cash an I bond in less than five years you'll forfeit the last three months' accumulated interest.
• Co-ownership of I bonds will not be allowed for the 2010 tax filing season. You can buy a bond only in your name or, if you're married and filing jointly, it will be in both spouses' names.

This article was reported by Laura Bruce for Bankrate.com.

Published Dec. 21, 2009