Savings bonds are a cornerstone of conservative investing, offering a secure and reliable means to grow one’s wealth over time. Yet, many people remain unclear about the intricacies of this financial instrument.
In this article, we aim to demystify this valuable financial tool by delving into its core characteristics, advantages, and practical applications. Whether you’re an individual seeking to diversify your investment portfolio or a professional aiming to optimize your financial strategies, understanding the ins and outs of savings bonds can be a game-changer.
What is a savings bond?
Savings bonds are a low-risk, U.S. government-backed investment that you can buy to help raise funds over time. When you purchase one, you are loaning money to the government. In return, the government promises to repay the amount you invested with interest.
Electronic savings bonds are simple to buy, safe to invest in, and affordable. You receive interest payments, and the bonds purchased can go to many purposes later, such as qualified education expenses. The purchase amounts range from a minimum investment of $25 – $10,000. However, there are maximum purchase limits per calendar year depending on the type of bond you purchase.
How do savings bonds work?
Think of a savings bond as a loan to the government. While there are a few rules, the main idea is that the government promises to pay back your loan through interest payments.
The government sets the interest rate for the loan, which doesn’t change for the bond’s duration. You buy these bonds at face value.
Savings bonds offer fixed terms, meaning they mature at a specific date. Once they reach that state, you can redeem them for their total value – plus interest.
The type of bond you purchase determines the maturity date. Some can take up to 30 years, while others take much less time.
Different Types of Savings Bonds
There are two main types of savings bonds in the US today, both a fixed rate, while paper bonds are slowly being phased out.
The U.S. Government issues two main types at face value: Series I Bonds and Series EE Bonds. Below is an overview of what each entails.
Series I Bonds
A Series I U.S. Savings Bond is a type of bond that offers a fixed interest rate that adjusts for inflation. The bonds are sold at face value, meaning that the price you purchase savings bonds for is what it is worth once the bond reaches maturity. With I Bonds, you can protect your investment from the variable inflation rate.
The government sets the I Bond inflation rate twice annually, once for each upcoming six-month period.
The current interest rate is 6.89% for I Bonds issued between November 1, 2022, to April 30, 2023.
I Bonds can earn interest for up to 30 years unless you decide to cash them out beforehand. You can buy them from the U.S. Treasury using a TreasuryDirect account or purchase paper bonds using your IRS tax refund.
Series EE Bonds
Series EE Savings Bonds are savings bonds that earn interest regularly for up to 30 years. The government guarantees that the Series EE Bond doubles in value in 20 years, even if it needs to add money at 20 years to reach that number.
Series EE bonds differ from I bonds in multiple ways. Primarily, they are not inflation adjustable. The second is that new EE bonds are only available for electronic purchase.
The government applies the bond’s interest rate to a new principal every six months. A principal is the sum of the previous principal and the fixed rate of interest in the past six months.
As of 2005, new EE Bonds earn a fixed interest rate set on the day you buy a bond. After 20 years pass, the government may adjust the interest on it.
When should I consider a savings bond?
You can buy a savings bond anytime, depending on your finances and long-term investment goals. There are multiple reasons why buying bonds is a good idea for later, however, such as:
- Their low-risk nature
- They generate a stable and low-risk investment
- The interest earned on them is exempt from state and local taxes
- Any investor with $25 and above can buy them
- Bonds pay back, helping you plan for the future
- Enjoying the stability of a fixed rate of interest announced twice annually
Are savings bonds worth it?
Savings bonds are worth the investment if you are looking for a stable way to increase your money at a reliable, fixed rate. If you want faster and higher returns, saving bonds may not be your best option. Remember that you do have to pay federal taxes as the bonds accrue interest, but not state or local taxes.
Ultimately, the selling point for purchasing a savings bond is a stable and safe return on your investment. Not all investments you make come with a guarantee as solid as the one you can get from the government.
The TreasuryDirect website also lets you send an announcement to someone to let them know you purchased a savings bond for them as a gift.
How do I redeem my savings bonds?
Redeeming a savings bond is usually an uncomplicated and seamless process. If you purchased your bonds electronically, such as the Series EE or Series I bonds, you could cash them in through your online TreasuryDirect account. Once you do so, you will receive your money in a checking or savings account of your choice in a few business days.
If you purchased older paper savings bonds, you could redeem them at financial institutions where you have an account. The option to cash in a bond at a bank or credit union depends on how long you had an account with them.
For older series of savings bonds, like HH bonds, you can’t redeem them through banks or credit unions. The FAQ section will cover HH bonds as the government no longer issues them.
For HH Bonds, you must complete a specific form called the FS Form 1522. Once completed, you must mail the bond with a certified signature and direct deposit information to the Treasury Retail Securities Services.
Early Withdrawal Penalty
Sometimes, a circumstance may force you to withdraw your savings bond early. Although not advisable as savings bonds are long-term investments, you still have options when something unexpected happens.
Series EE and Series I savings bonds have an early withdrawal penalty if you redeem them less than five years after their issue date.
So, if you cash in the bond before the five-year mark, you receive the principal amount plus the interest earned up to that point minus the interest accrued in the past three months.
After the five-year mark, there are no penalties for redeeming your savings bond. You can receive the total value of the principal and interest earned.
Savings Bonds vs. Savings Accounts vs. Certificates of Deposit (CDs)
A savings account and a CD are financial products that banks and credit unions offer. With a savings account, you can deposit money and earn interest on electronic bonds over time. A CD is when you keep a specific amount of money with the bank for a timeframe in exchange for fixed interest rates.
Although savings accounts and CDs are low-risk investment options, they are not backed by the government like savings bonds. And unlike savings bonds, you must pay federal, state, and local income taxes for CDs and savings accounts.
Benefits and Drawbacks of Investing in Savings Bonds
In terms of benefits, an electronic bond comes with low-risk, guaranteed returns backed by the government. You can use them as a future nest egg, for retirement, or to fund a child or grandchild’s education. Moreover, they come with tax benefits. The federal government allows exemptions on state and local taxes and are simple to buy and later redeem. Keep in mind that you do have to pay federal income tax on them in some cases.
One drawback to electronic bonds is the time it takes to make a solid amount of interest like a money market account. Additionally, they do not offer the potential for capital gains, only from the interest accrued over time. Finally, if you do not have a Series I bond, you do not have sufficient protection against inflation.
Bottom line: Savings bonds are an excellent investment option if you are looking for guaranteed returns by the United States government. Although it takes time to get their full benefit, they are a reliable way to save money, helping you plan for the future or pay tuition for college. You don’t have to worry about a variable interest rate, and the interest payment is always stable.
Savings Bonds FAQ
Where can I purchase savings bonds?
You can purchase savings bonds online from the U.S. Department of the Treasury through their online platform, www.treasurydirect.gov. Buying from the treasury guarantees safety and security. Paper bonds can only be purchased for Series I U.S. savings bonds. Additionally, you can only pay for a paper bond using a tax return.
What is an HH savings bond?
HH savings bonds offer semi-annual interest directly to the bondholder. They were only available as a paper bond by exchanging Series EE or Series E bonds. The government discontinued them in 2004, and they are no longer available for sale. However, some HH bonds are still redeemable depending on their year of purchase.