The Ins, Outs, and All-Arounds of US Savings Bonds were written by Sam Stone and originally appeared on Hello Sensible. Sam is the creator of the personal development blog Smarter and Harder. His mission is to start exciting new conversations that empower people to improve their work, lives, and money, and have fun doing it. In all things, he strives to lead with positivity, understanding, and more than a bit of enthusiasm. It has been republished with permission. Please note that contributing opinions are that of the author. They are not always in strict alignment with our own opinions.
Although they wax and wane in popularity over the years, bonds remain a core portfolio component for many investors.
In particular, US savings bonds combine the stability of a fixed-income investment with the confidence of investing in one of the most financially stable governments in the world.
The returns on savings bonds don’t always measure up to those of riskier securities, but they offer far more than their cash return alone. With their modest-but-reliable interest rates, unique tax advantages, convenience, and income possibilities, savings bonds are excellent tools for consistent wealth-building.
Investing in Savings Bonds
When you buy a bond, you invest in corporate or government debt. The bond’s purchase price amounts to a small loan to the institution that issued it. In exchange, that organization will pay you an interest rate on the bond for a set term.
When you buy a US savings bond, you issue a loan to the US federal government, on which it then pays you interest over time.
Bonds typically bridge the gap between hyper-stable bank accounts offering next to no return on your money and equities like stocks providing higher returns for higher risk. While there are some types of bonds with higher risk and a chance of higher rewards, they are typically a more conservative instrument.
In particular, US savings bonds are among the most stable and reliable investment vehicles in their class. Moreover, since they are backed by the full faith and credit of the US government, the only risk to your savings bonds is if the federal government were to become completely insolvent.
This level of security and confidence offers investors several key advantages for holding savings bonds.
Advantages of Savings Bonds
For several reasons, many investors prefer to keep a portion of their portfolios in bonds. Bonds facilitate cash flow into a portfolio as an investment that primarily offers income instead of growth. Bond owners can then leverage this income in various ways, such as:
- Reinvesting into more bonds and growing their passive income
- Funneling into their long-term growth investments
- Supplementing their regular employment income to pay bills, save, etc.
- Any combination of the above
The overall return potential of bonds is typically lower than more aggressive investments like stocks. However, the stability and income advantages of bonds make them a popular counterpart to growth investments.
Savings bonds are especially effective as a hedge against riskier securities. Their backing from the US Treasury leaves a near-zero chance that investors will not earn their expected returns. Therefore, investors can protect their money without incurring the opportunity cost of a no-risk portfolio.
Savings bonds also have several unique advantages over other types of bonds.
For instance, local and state taxes do not apply to income on treasury bonds. Instead, their income is only susceptible to federal capital gains tax.
Another advantage is that a minor can hold savings bonds in their own name. This rule is one reason savings bonds are popular gifts from relatives to their nieces, nephews, and grandchildren. Their low risk is also a great way to teach children about the possibilities of growing their money over time.
Types of Savings Bonds
The US Treasury currently offers two types of savings bonds, series EE and series I. The two are pretty similar in practice. Both follow the same term, have the same tax advantages, and primarily exist online. But as always, carefully choosing what you buy can make a significant difference.
Series EE Savings Bonds
Series EE bonds last for 30 years. They have a guaranteed fixed interest rate for the first 20 of those 30 years. During the final ten years of the term, the interest rate on EE bonds may change but won’t necessarily do so.
The US Treasury guarantees that the value of an EE bond will double over the first 20 years of the term.
Some people still own paper EE bonds issued before 2012, which are still valid. However, since that year, the treasury has no longer issued new paper EE bonds. All new EE bonds are now electronic through TreasuryDirect. Electronic bond owners can track their investments in an online account that earns monthly interest.
As well as convenience and security, online bonds offer the advantage of flexibility. While paper EE bonds only came in specific denominations, such as $50 or $100, you can purchase electronic bonds for any value from $25 to $10,000. So, for instance, if you want to buy precisely $74.20 in electronic EE bonds, you can.
Series I Savings Bonds
The most significant difference between EE and I bonds is how they earn interest. While EE bonds earn a fixed rate for the first 20 years, I bonds earn variable interest rates tied to inflation.
The treasury calculates a new rate for series I bonds semiannually, in November and May. The result is a combination of a fixed base interest rate and one that is based on inflation. So over a 30-year term, an I bond’s interest rate could change up to 60 times. However, the treasury guarantees that this rate will never fall below zero.
While, like EE bonds, I bonds now exist primarily online, there is one exception. Investors still have the option to buy paper I bonds, but there is only one way to do it: using their IRS tax refund.
Other than using a tax refund, the only way to buy new I bonds is to do so electronically. However, like EE bonds, paper I bonds from before 2012 are also still in circulation until the last of them mature in about 20 years.
What Are My Savings Bonds Worth?
If you already own savings bonds and want to find their present value, the answer will depend on whether they are paper or electronic.
When you buy bonds online, they are immediately worth their face value and earn interest for the remainder of their term. For instance, a $50 bond is worth $50 the day you buy it and gains compound interest until its maturity date. Finding how much interest you have accrued is as simple as logging into your TreasuryDirect account and checking your balance.
However, there are some restrictions on electronic bonds. For example, holders cannot cash them for the first 12 months. In addition, cashing these in the first five years will result in forfeiting the most recent three months of interest income.
Paper bond values are slightly more complex. When you buy a paper bond, it is initially worth less than its face value. It then follows an accrual schedule to reach and grow beyond that value. Fortunately, TreasuryDirect offers a handy bond calculator where you can plug in the details of your bonds and see what your accrued interest and total bond value are today.
How to Buy Savings Bonds
Once again, the difference between paper and electronic bonds is a crucial distinction in how they work.
Buying electronic savings bonds could not be much simpler. First, you must create a TreasuryDirect account if you don’t have one. Once you access your account, you can buy EE or I bonds through their BuyDirect option. You can then select the type you want to buy, the denomination, and other basic info.
You can buy up to $10,000 in each type of bond per year per social security number.
If you want to buy paper bonds, the only option is I bonds, and there is only one way to do it. If you have a federal tax refund from the IRS, you can file IRS form 8888 to specify the amount of that refund that you would like to use to buy paper I bonds.
You can buy up to $5,000 of paper bonds yearly in $50 increments. This amount is in addition to the allowance for electronic bonds.
How to Redeem Savings Bonds
Redeeming electronic bonds is as straightforward as buying them. All you need to do is log into your TreasuryDirect account and navigate to the screen for selling securities from your account.
Remember that there are penalties for selling these bonds within the first five years. So if you want to keep all the interest your bonds accrue, you will need to keep them for at least that long.
Cashing in paper savings bonds is also a relatively painless process, unlike buying them. Most major banks will redeem them for you if you have an account with them. However, some banks will restrict how much they will cash at once and may require you to complete some paperwork.
You can also cash paper bonds directly through the treasury using FS form 1522.
However you cash your bonds, remember to keep track of the amounts and income. You will need this information for your income taxes, and it is always easier to have everything you need ahead of time.
Income, Dependability, and You
Whether you’re a veteran investor with a massive portfolio or looking to put $25 away to start your college savings, US bonds have something to offer everyone. They are one of the safest ways to gain reliable interest on your savings and improve your financial circumstances.
While the interest on savings bonds likely won’t make anyone rich overnight, they are still valuable to any investor’s portfolio. This is because they mitigate portfolio risk while also introducing a source of passive income to continue building one’s portfolio in several ways.
Don’t let relatively low-interest rates dissuade you: savings bonds can be an essential wealth-building tool at any scale.