How to use your tax refund to buy savings bonds

Treasury tax check with cash.

(MoneyWatch) The U.S. Department of Treasury is offering folks a new way to put their tax refunds to work.

Under its "Ready, Save, Grow" initiative, the agency is offering the option to buy Series I Savings bonds in amounts ranging from $50 to $5,000. Under this program, Series I Savings bonds can be purchased with all or a portion of your tax refund and bought in paper or electronic form.

"The average annual tax refund of $3,000 can be compounded over time when invested in Savings bonds. I encourage tax refunds recipients to learn more about the benefits as they plan for long term savings goals," said Jerry Kelly, national director of the Ready, Save, Grow campaign.

To buy savings bonds with you tax refund, tax payers need to fill out "Form 8888, Allocation of Refund (Including Savings Bond Purchases)." If you want to purchase the bonds in electronic form, you can choose to have your refund deposited into a Treasury Direct account, where you'll then buy the bonds. That means you also need to set up an account at Treasury Direct, which can make it easier to manage these bonds if you buy them every year. You can also buy these bonds in paper form, and you can use your tax refund to purchase them as a gift to others, such as for your children or grandchildren.

Series I Savings bonds earn a composite interest rate, which is the combination of two rates -- a fixed rate and a semi-annual inflation rate. The fixed rate on I Bonds is currently set at 0 percent and remains fixed for the entire period beginning from the date of issue until the bonds expire in 30 years. I Bond fixed rates are determined each May 1 and November 1. Each fixed rate applies to all such bonds issued in the six months following the rate determination for that period.

The semi-annual inflation rate for Series I Savings bonds is an interest rate indexed to an inflation rate, known as the Consumer Price Index for all Urban Consumers (CPI-U). The semi-annual inflation rate is determined each May 1 and November 1. Each semiannual inflation rate applies to all outstanding I Bonds for six months. The current semi-annual inflation rate is 1.76 percent.

A rate of 1.76 percent may sound paltry for a long-term investment -- and it is. But you can sell these bonds anytime after you've owned then for at least one year. If you sell within five years, you'll lose three months of interest. But even if you do, it's still almost double the interest rate people are currently getting on bank savings account and money market funds. Another advantage is that interest on I Bonds is not taxable until the bond is redeemed and is not subject to state or local tax. The interest can also be completely tax free if the bond is sold and the proceeds are used to pay for qualifying higher education expenses.

Should folks use I Bonds that currently earn 1.76 percent for their long-term investing goals? With so many other investments that have the potential to earn higher long-term returns, I don't think that's such a great thing to do. But these bonds can be useful as a way to save in the short-term.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.