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 be easily transferred and are non-negotiable.

BREAKING DOWN 'U.S. Savings Bonds'

Bonds are debt instruments through which an entity can raise capital to grow and expand its operations. A common type of bond is the government bond which is 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 the money, the government makes interest payments to its bondholders. One popular type of government bond is the US savings bond.

History of the US Savings Bond

Shortly after the Great Depression began, President Franklin D. Roosevelt signed legislation that allowed the U.S. Department of the Treasury to issue federally-backed savings bonds. The bonds were originally 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 towards 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. In addition, the funds obtained from selling the bonds to the public were used by the government to finance its day-to-day operations.

Features of US Savings Bond

  1. Non-Marketable: The US savings bond was designed to be non-marketable, meaning that an investor can only purchase the bond directly from the US government, and cannot sell it to any other investor. The bonds, in effect, cannot be transferred as they represent a contract between the investor and the US government. This direct relationship ensures that the US savings bond does not fluctuate in value. Therefore, an investor will receive his original investment if he redeemed the bonds. Furthermore, any lost or damaged savings bond certificate can be re-issued or replaced since the bond will be registered with the government.
  2. 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 the US Savings bond in a calendar year. The US Savings bond can only be purchased and redeemed electronically through the TreasuryDirect website administered by the government. The investor must open a TreasuryDirect account and is required to provide a Social Security Number (SSN), checking or savings account, and email address.
  3. Interest payment: The US savings bonds are zero-coupon bonds that do not pay interest until they are redeemed or until 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.
  4. Early redemption: The time it takes for a bond to mature varies, but it is often somewhere between 15 to 30 years. A bondholder must wait at least 12 months after initial purchase before redeeming the savings bond, at which point s/he will receive the face value plus some 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.
  5. 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 stops earning interest after 30 years. If the investor uses the proceeds from the bond redemption to pay tuition for higher education, he may be exempt from higher taxes.

The US Savings Bonds

The two types of US savings bond that can be purchased electronically are the Series EE and Series I bonds.

  • Series EE US Savings Bond: The Series EE savings bond replaced the Series E bond in 1980. The 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 US 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 upwards. During periods of deflation, the bonds are guaranteed to never drop below 0.00%.

In order to purchase or redeem a US 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 one of the safest types of investments because they are endorsed by the federal government and, therefore, are 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.

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