Savings Bonds to Pay Market Rates

WASHINGTON —  The U.S. Treasury said it will start to pay market-based interest rates on savings bonds issued on or after May 1.

Currently, the Treasury pays a fixed rate of interest on savings bonds held up to five years and a variable rate on those held five years or more. The change announced Monday will make the yield on savings bonds held for less than five years variable also, thereby ensuring that the interest the Treasury pays on savings bonds is in line with market rates.

“For the first time, savings bond investors will get market-based rates right from the start,” Treasury Secretary Robert E. Rubin said. “Whether interest rates are high or low, savings bond investors will always get a return linked to market rates, a fair return on their money.”

A senior Treasury official said the change wasn’t made to achieve a budget savings, although the Congressional Budget Office previously estimated that the Treasury could save $100 million over five years by switching to market rates on savings bonds.

“It became clear that the fixed minimum rate was cumbersome,” the senior Treasury official said. “We were reactive to changes in rates, acting after rates had fallen.”

As an example, the Treasury paid a fixed rate of 6% on savings bonds between November, 1986, and February, 1993. That became expensive for the Treasury in the second half of 1992, when the yield on 6-month Treasury bills averaged 3.38%.

Another reason for the switch is that “people are getting more comfortable with variable rates,” the Treasury official said. As examples, money market funds and many bank savings accounts pay variable rates.

Under the new system for Series EE savings bonds issued on or after May 1, the Treasury will announce two interest rates each May 1 and Nov. 1. One of these rates will apply to bonds less than five years old and the other to bonds more than five years old.

The Treasury will pay 85% of the average of six-month Treasury security yields on bonds less than five years old. The rate announced each May 1 and Nov. 1 will reflect market yields during the preceding three months. The rate on bonds more than five years old will be 85% of the average of five-year Treasury security yields. The long-term rate announced each May 1 and Nov. 1 will reflect market yields during the preceding six months.

Savings bonds are sold at half of their face value and accrue interest every six months. Investors who cash in their savings bonds between interest accrual dates won’t get any interest for the partial period since the last accrual date.

Because the bonds earn interest based on market rates, it is impossible to predict when a bond will reach its face value. However, the Treasury will make a one-time adjustment to increase savings bonds to their face value if market rates don’t bring them to that level in 17 years. A bond needs to yield an average of 4% to double in value in 17 years.

The approximately $180 billion in savings bonds now outstanding isn’t affected by these changes. One in four American households owns savings bonds, making them among the most widely held securities in the world. They can be purchased from banks and the Federal Reserve in denominations as low as $50, making them popular gifts for children.