What Are U.S. Savings Bonds?
A U.S. savings bond is a government bond offered to its citizens to help fund federal spending, and which provides savers with a guaranteed, although modest, return. These bonds are issued with zero coupon at a discount with an implied fixed rate of interest over a fixed period of time.
For instance, Series EE savings bonds are sold at 50% of their face value, and mature to their full value after 20 years.
Key Takeaways
- U.S. savings bonds are a form of government debt issued to American citizens to help fund federal expenditures.
- Savings bonds are sold at a discount and mature to their full face value, and do not pay regular coupon interest.
- Series EE bonds are sold at half of face value and mature in 20 years. Series I bonds are adjusted for inflation.
Understanding U.S. Savings Bonds
A U.S. savings bondisa 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 withcapital, the government makes interest payments to its bondholders.
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.
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 federallybacked savings bonds, Series A. In 1941, the Series E bond was first issued to help finance World War IIand were called Defensive Bonds. After the attack on Pearl Harbor, they were called War Savings Bonds, and the money invested in them went directly towardthe 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. governmentand 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 their original investment if they 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 ofU.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 the initial purchase before redeeming the savings bond, at which point they will receive the face value plusinterest. 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 bondstops earning interest. If the investor uses the proceeds from the bond redemption to pay tuition for higher education, they may be exempt from higher taxes.
Types ofU.S. Savings Bonds
There are presently two types of U.S. savings bonds that can be purchased electronically are the Series EE and Series I 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 interestadjusted 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%.
- Series HH bonds are no longer available for purchase. The U.S. government discontinued these bonds as of Aug. 31, 2004.Bonds that didn't mature continued to receive interest payments. The Series HH bond were 20-year,non-marketablesavings bond issued by the U.S. government.
Other Considerations
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 amongthe safest types of investments, asthey 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.
