How Do Savings Bonds Work?

Savings bonds are a popular investment vehicle for individuals who want a safe, low-risk way to save money over time. They are issued by governments, particularly the U.S. Department of the Treasury, and provide a predictable, if modest, return on investment. For those unfamiliar with the intricacies of savings bonds, this guide will break down how they work, their benefits, drawbacks, and how to purchase and redeem them.

What Are Savings Bonds?

Savings bonds are debt securities issued by the government to fund federal spending. They are considered a secure investment because they are backed by the full faith and credit of the government. In essence, when you purchase a savings bond, you are lending money to the government, which it agrees to repay with interest over a specified period.

Types of U.S. Savings Bonds

The most common types of savings bonds in the United States are Series EE and Series I bonds.

• Series EE Bonds: These are traditionally the main type of savings bonds. They earn a fixed interest rate, determined at the time of purchase. EE bonds are guaranteed to double in value over their initial term of 20 years, with the possibility of continuing to earn interest for up to 30 years.

• Series I Bonds: These bonds earn interest based on a combination of a fixed rate and an inflation rate, adjusted semiannually. The interest from I bonds will vary throughout their life, offering protection against inflation.

How Do You Purchase Savings Bonds?

Savings bonds can predominantly be purchased electronically through the TreasuryDirect website. Here's a step-by-step guide on purchasing them:

1. Create a TreasuryDirect Account: Visit the TreasuryDirect website to set up an online account where you can manage your savings bonds.

2. Choose the Bond Type: Decide whether you want to invest in Series EE or Series I bonds based on your financial strategy and inflation outlook.

3. Determine the Amount: Decide the amount you wish to invest. You can buy as little as $25 or as much as $10,000 per series each calendar year for electronic bonds.

4. Make the Purchase: Follow the prompts on TreasuryDirect to finalize your purchase, including inputting banking details for payment.

5. Manage Your Bond: Once purchased, electronic savings bonds stay in your TreasuryDirect account. You’ll be able to track interest earnings and maturity dates through this portal.

Savings Bond Table: Series EE vs. Series I

How Do Savings Bonds Earn Interest?

Savings bonds earn interest based on their type during their lifetime, credited monthly, and compounded semiannually. Here's how it works for each type:

• Series EE Bonds: The interest rate is fixed when the bond is issued. The U.S. Treasury guarantees that these bonds will double in value if held for 20 years. If held beyond 20 years, they will continue to accrue interest, up to 30 years, but at the same initial rate.

• Series I Bonds: These earn interest from both a fixed rate and an inflation rate, which is adjusted every six months. The unique feature of I bonds is their inflation protection, which helps maintain purchasing power over time. Interest is compounded semiannually.

How to Redeem Savings Bonds

Savings bonds can generally be redeemed after 12 months from the issue date. However, if you redeem them before five years, you will lose the last three months of interest. For instance, if you cash out at 18 months, you will receive the initial investment plus 15 months' worth of interest.

Steps to Redeem Electronic Bonds:

1. Log Into TreasuryDirect: Access your account to view your bonds.

2. Select the Bond: Choose the bond you wish to redeem from your holdings.

3. Initiate Redemption: Follow the specific instructions on the platform to begin the redemption.

4. Receive Funds: The redemption amount, minus any penalty if applicable, will be deposited into your linked bank account.

Steps to Redeem Paper Bonds:

1. Verify Ownership: Ensure you are the named owner or co-owner.

2. Visit a Financial Institution: Take the paper bond to a bank or credit union. You will need identification such as a driver's license or passport.

3. Cash the Bond: The bank will process the redemption, and you'll receive funds in your account.

The Benefits and Drawbacks of Savings Bonds

Benefits

• Safety and Security: Backed by the U.S. government, savings bonds are among the safest investment forms.

• Tax Benefits: Interest earned on savings bonds is exempt from state and local taxes. Additionally, you may avoid federal taxes if the bonds are used for qualified educational expenses.

• Low Entry Requirement: With a minimum purchase of just $25, they are accessible to many investors.

Drawbacks

• Low Returns: Compared to other investments, savings bonds typically offer lower returns.

• Long Maturity Periods: To gain the full benefit, bonds need to be held to maturity, which can mean tying up funds for up to 30 years.

• Early Redemption Penalty: Cashing in before five years means losing three months of interest.

FAQs About Savings Bonds

1. Can I gift savings bonds to someone else?

Yes, you can buy savings bonds as gifts, but the recipient must have a TreasuryDirect account to receive them.

2. Are savings bonds a good investment?

Savings bonds are an excellent choice for risk-averse individuals looking for a secure investment. They are not designed for aggressive growth but offer stable returns.

3. How often do interest rates for Series I bonds change?

The interest rates for Series I bonds change every six months, in response to inflation rates.

4. Can savings bonds be held jointly?

Yes, savings bonds can have a primary owner and a co-owner or beneficiary, which can be set up during the purchase process.

By understanding the features and implications of savings bonds, investors can make informed decisions that align with their financial goals. Consider exploring additional resources on topics such as investment diversification to further broaden your savings strategy.