What are U.S. Savings Bonds
A U.S. savings bond is a government bond that offers a fixed rate of interest over a fixed period of time. Many people find these bonds attractive because they are not subject to state or local income taxes. These bonds cannot easily be transferred and are non-negotiable.
BREAKING DOWN U.S. Savings Bonds
A U.S. savings bond is a common type of government bond, which is a bond issued by a governmental body to raise funds from the public to fund its capital projects and other operations necessary to manage the economy. When the government sells bonds, it is in effect taking a loan from the public, which it promises to pay back at some predetermined date in the future. As compensation for providing it with capital, the government makes interest payments to its bondholders.
History of the U.S. Savings Bond
In 1935, during the Great Depression, President Franklin D. Roosevelt signed legislation that allowed the U.S. Department of the Treasury to issue federally backed savings bonds, Series A. In 1941, the Series E bond was first issued to help finance World War II and were called Defensive Bonds. After the attack on Pearl Harbor, they were called War Savings Bonds, and the money invested in them went directly toward the war effort.
After the war ended, Americans were encouraged to purchase savings bonds, which provided a way for individuals and families to earn returns on their investments while enjoying the absolute guarantee of the United States government.
Features of U.S. Savings Bonds
- Non-Marketable: The U.S. savings bond was designed to be non-marketable, meaning that an investor can only purchase the bond directly from the U.S. government and cannot sell it to any other investor. The bond, in effect, cannot be transferred, as it represents a contract between the investor and the U.S. government. This direct relationship ensures that the U.S. savings bond does not fluctuate in value. Therefore, an investor would receive his original investment if he redeemed the bond. Furthermore, any lost or damaged savings bond certificate can be reissued or replaced, since the bond is registered with the government.
- Purchase: An investor can buy the bonds in penny increments with a minimum investment value of $25 and a maximum value of $10,000. A bond investor cannot buy more than $10,000 face value of U.S. savings bonds in a calendar year. U.S. savings bonds can only be purchased and redeemed electronically through the TreasuryDirect website administered by the government. The investor must open a TreasuryDirect account and provide a Social Security Number (SSN), checking or savings account, and email address.
- Interest payment: U.S. savings bonds are zero-coupon bonds that do not pay interest until they are redeemed or until the maturity date. The interest compounds semi-annually and accrues every year for 30 years. After a bond has been held for 30 years, it will no longer generate interest payments to the investor. An investor who purchases the bond at the end of the month will still receive the interest accrued for the entire month. Any interest paid at redemption or maturity date is issued electronically to the bondholder’s designated bank account.
- Early redemption: The time it takes for a bond to mature varies, but it is often between 15 and 30 years. A bondholder must wait at least 12 months after initial purchase before redeeming the savings bond, at which point he will receive the face value plus interest. Furthermore, investors who redeem the bonds within the first five years of purchase will forfeit the last three months’ interest as a penalty. However, redeeming a bond after holding it for five years does not incur any penalty.
- Tax consequences: The interest earned from savings bonds is exempt from state and local income taxes. However, federal taxes apply, but only in the year in which the bond matures, is redeemed, or after 30 years, when the bond stops earning interest. If the investor uses the proceeds from the bond redemption to pay tuition for higher education, he may be exempt from higher taxes.
Types of U.S. Savings Bonds
- Series EE U.S. Savings Bond: The Series EE savings bond replaced the Series E bond in 1980. These bonds are sold at face value and are worth their full value upon redemption. These bonds offer a fixed rate of interest, which is paid at maturity or redemption.
- Series I U.S. Savings Bond: The Series I savings bond was introduced in 1998. Like the Series EE bond, the Series I is sold at face value. These bonds offer a rate of interest adjusted for inflation, making the interest rate somewhat variable. If inflation increases, the interest rate on the savings bond will be adjusted upward. During periods of deflation, the bonds are guaranteed never to drop below 0.00%.
In order to purchase or redeem a U.S. savings bond, an investor must be a U.S. citizen, official U.S. resident, or U.S. government employee (regardless of citizenship status).
U.S. savings bonds are among the safest types of investments, as they are endorsed by the federal government and are, therefore, risk-free. Although these bonds do not earn much interest compared to the stock market, they do offer a less volatile source of income. They offer a way to save for future expenditures, as they cannot be cashed until at least 12 months after purchase, and the longer you wait to cash the bond, the more interest it accrues. (For related reading, see "How Are Savings Bonds Taxed?")