Savings bonds are debts that are taken by the US government through issuance of redeemable interest-earning tokens. Based on this logic, buying a bond means lending money to the government. Because of the US strong economic and political standing, the US Treasury is among the most trusted bond issuers.
How can you invest in them?
Even if you’re under 18, you can own or co-own a savings bond. Only the person who buys a bond or a beneficiary can cash a bond.
Savings bonds are obtainable through purchase on TreasuryDirect.gov, where they are sold in electronic format. While electronic bonds have replaced paper bonds, you can still redeem the old paper bonds from approved financial institutions. You cannot sell your bonds directly to another party or deposit them in a brokerage account, unlike other financial assets.
It is advisable to hold onto your savings bonds for at least five years before redeeming them. This is to protect you from losing the interest earned. Doing otherwise will result in interest rate penalties. However, you are free to redeem after one year, but the downside to premature redemption is that you not only miss out on the interest yield, but end up with sub-optimal earnings.
Types of savings bonds
Until August 2004, there were three types of savings bonds. However, there are currently only two types issued, following the scrapping of HH bonds 17 years ago. These two are discussed below.
Series EE: Series EE bonds are sold at face value and they are also redeemed at an equivalent value. For instance, if you bought $100 worth of bonds, you will earn $100 at maturity and the interest yield will be deposited to your chosen bank account. Legally, you can only buy a maximum of $10,000 worth of Series EE bonds per year. Redeeming your bonds less than five years after purchase results in penalties equivalent to the interest yields of the most recent three months. However, you will not be penalized if you redeem after five years.
Series I: Series I are bonds whose earnings are periodically adjusted, in line with the fluctuations in interest rates. They are sold at a face value of $10,000 and an individual investor cannot buy more than that amount in a year. Like Series EE, redeeming them less than 5 years after purchase leads to a 3-month interest penalty, applied on the most recent 3 months. Redeeming after five years does not incur penalties.
Advantages of investing in savings bonds
Savings bonds have a number of advantages, including the ones below.
- Benefits from lower taxes: State and local taxes are not levied on bond interest, and federal taxes can be deferred until the bond is cashed in or expires. Aside from that, taxpayers who use savings bonds for approved educational expenses receive tax benefits.
- Savings bonds are popular as gifts since they can be used to pay for college, provide additional income in retirement, and cover other special occasions. Savings bonds are the only type of investment that allows minors to own them in their own name, unlike other types of securities.
- Hedge against inflation: Holders of Series I bonds benefit from the fact that the yields are adjusted to inflation. This can cushion them against rising consumer price inflation. Series I bond yields will rise if inflation increases. The bond’s interest rate will drop if inflation goes down.
- There are no fees incurred while purchasing bonds, unlike many securities. They’re offered for sale as-is. The price you’ll pay for a $50 bond will be exactly $50.
The downside to savings bonds
- The low yields on savings bonds, as well as their inflexibility, are their biggest drawback.
- There is no soft landing for those who redeem them in less than a year. Doing so will result in a penalty equal to three months’ worth of interest.
- If you don’t utilize the money for higher education, you’ll owe federal income taxes when you redeem the bond.
How should you redeem your savings bond?
If it’s a paper bond, you can get your money back by going to a physical bank or credit union in person. Don’t forget to bring an ID and the savings bond. A tax form will be sent to you, either immediately or by mail, depending on how the bank processes your account. Next procedures are outlined in the Treasury’s instructions if a bank refuses to accept your bond.
Register for an account at TreasuryDirect.com and then follow the procedures to confirm redemption and deposit into a linked bank account if you have an electronic bond. You should get the money in your account within two business days.
In summary
Knowing how and what to expect from a savings bond investment is critical if you want to make the most of it. Your money is on long-term loan to the government, which pledges to reimburse you at a later date with interest. You should carefully consider this against other available investment options.
