Reinventing the Dowdy Savings Bond

Families with low and moderate incomes have difficulty saving money—many can't even open bank accounts. To help these families plan for the future, professor Peter Tufano proposes minor changes to the U.S. savings bonds program. Key concepts include:
  • Encourage savings by offering the option to invest tax refunds in U.S. savings bonds.
by Julia Hanna

In the family of investment products, a U.S. savings bond might be cast as boring old Uncle Ned, snoozing away in the corner after dinner. There's nothing wrong with that—but HBS professor Peter Tufano envisions a more meaningful role for savings bonds in the financial lives of low- and moderate-income families.

Low-risk and low-profile, savings bonds have been around for decades, offering the dual benefit of funding the national debt while acting as a savings vehicle for millions of Americans. In "Reinventing Savings Bonds," an article in Tax Notes (October 31, 2005) with Daniel Schneider, Tufano proposes a slight renovation of the program that will make it easier for asset-poor families to use savings bonds to build a nest egg for the future.

Families living paycheck to paycheck rarely squirrel away funds to survive a financial emergency. For many, the one big check each year comes in the form of an income tax refund. In 2001, the IRS returned $78 billion to families making less than $30,000 annually, for an average return of $1,546 per filer.

To Tufano, that check suggested itself as an ideal "saving opportunity." What would happen if low- and moderate-income families (LMI) families were given the option of redirecting some of their refund to savings? Would they take advantage?

The Tax Test

Tufano and a cross-sector team of nonprofit and private sector organizations explored those questions in an experiment in Tulsa, Oklahoma, in early 2004. Over the course of four weeks, representatives at two Volunteer Income Tax Assistance (VITA) sites offered filers the option of splitting their refunds, depositing all or some of their refund into an existing or new savings account with the Bank of Oklahoma while receiving the remainder to spend. Fifteen percent participated, saving $606 on average. Ten percent were turned away from opening a savings account due to prior bad financial management, i.e., having a bank account closed for non-sufficient funds.

"I don't believe the federal government should pass a law that a bank should be required to accept a customer, but everyone has the right to save if they want to work to do that," Tufano says. "So let's think about what the characteristics of a universal savings vehicle might be: It's low cost, low risk, portable, available in small denominations, and has some liquidity. What's being described is the savings bond program."

Unfortunately, recent changes to the program have made it a less attractive, less accessible product for LMI families. In January 2003, for example, the Department of the Treasury increased the minimum holding period for bonds from six to twelve months. Marketing for the program was also eliminated. While all banks sell bonds, the $.50 to $.85 they earn for each transaction gives them little financial incentive to make the process easy for consumers. Finally, the Treasury's preference to migrate the sale of bonds to its online Web site will exclude customers without Internet access or a bank account.

That strikes me as a relatively small investment to make for a relatively large number of individuals.

Tufano suggests a few adjustments to "reinvent" the savings bond program, such as allowing small withdrawals in case of emergency before twelve months. More substantively, he proposes adding a line to the 1040 tax form that would allow filers to invest a part of their refund directly in the savings bond program, making it simpler for people to buy bonds.

"We don't need any budget appropriations or new social programs," he says. "The money is there at refund time. We just need to help families try to save some of it."

Easy To Buy

Other recommendations Tufano offers include marketing the program through volunteer tax preparers; the creation of a bond-based retirement product, or "R-bonds;" allowing bonds to be rolled over into private sector retirement accounts; and generally making it easier to purchase bonds by expanding distribution to outlets such as the post office and Wal-Mart.

"The federal government spends $350 billion each year on asset support policies that benefit the top 20 percent of the American population," observes Tufano. "What we're talking about is a little replumbing of the IRS code and the Bureau of Public Debt to help the remaining 80 percent of American families to save. That strikes me as a relatively small investment to make for a relatively large number of individuals."

We don't need any budget appropriations or new social programs.

In discussions with the Treasury, Tufano says he encountered healthy skepticism to the idea that such changes would create real demand for savings bonds. To further test the concept, he and his team offered filers the option of investing part of their refunds in savings bonds at fifteen H&R Block offices north of Chicago in March and April 2006. This pretest was designed to pave the way for more substantial experimentation this coming year.

"It's too small a sample to draw conclusions, but initial indications would suggest that savings bonds might be as attractive to as many savers as on-site funding of an IRA," says Tufano, who plans to return for more on-the-ground testing in early 2007.

Not A Perfect Solution

"I make no claim that savings bonds are the perfect product," he adds. "But they're an attractive product for some savers, particularly those who find it difficult to open a bank account and want to put some money where they're not going to think about it."

For now, Tufano has the satisfaction of seeing his efforts create tangible change. In part as a result of the Harvard research on refund splitting, the IRS will introduce Form 8888 in 2007, which will allow taxpayers to send some or all of their refund to as many as three different financial accounts. It's a far cry from the simpler scenario of checking a "savings bond" box on the 1040 form—but it's a start.

Tufano is the Sylvan C. Coleman Professor of Financial Management at Harvard Business School. He is a senior associate dean of the school and serves as the school's director of faculty development. He studies the organization and operations of financial institutions, particularly the mutual fund industry. His work has focused on the determinants of fund flows, the impact of alternative governance structures on fee setting, the evolution of competition, and underlying economics of the industry.

Recently, he has been researching the delivery of financial services to the poor, with particular attention to their need to build assets. He is the founder and chairman of D2D Fund, Inc., a nonprofit that attempts to turn these ideas into practice through businesses and government policies.

About the Author

Julia Hanna is Associate Editor of the HBS Alumni Bulletin.