U S Savings Bonds Definition How They Work Types and Taxes

U.S. Savings Bonds: Definition, How They Work, Types, and Taxes

Ariel Courage is an experienced editor, researcher, and former fact-checker. She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street.

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 provide savers with a guaranteed, although modest, return. These bonds are issued with zero coupon at a discount and have an implied fixed rate of interest over a fixed period of time.

For instance, Series EE savings bonds are sold at 50% of face value and mature after 20 years.

Key Takeaways

– U.S. savings bonds are government debt issued to American citizens to fund federal expenditures.

– Savings bonds are sold at a discount, 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 bond is a common type of government bond, issued to raise funds for capital projects and manage the economy. When the government sells bonds, it is taking a loan from the public, promising to pay it back at a later date. In exchange for capital, the government makes interest payments to bondholders.

Many people find these bonds attractive because they are not subject to state or local income taxes and cannot be easily transferred or 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 federally backed savings bonds, Series A. In 1941, the Series E bond was first issued to help finance World War II. After the attack on Pearl Harbor, they were called War Savings Bonds, and the money invested in them went directly toward 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 government.

Features of U.S. Savings Bonds

– Non-Marketable: U.S. savings bonds are non-marketable, meaning investors can only purchase them from the U.S. government and cannot sell them to other investors. The bond represents a contract between the investor and the government, ensuring its value remains constant.

– Purchase: Bonds can be bought in penny increments, with a minimum investment value of $25 and a maximum value of $10,000. Purchases and redemptions can only be done electronically through the TreasuryDirect website, requiring a TreasuryDirect account, Social Security Number (SSN), and bank account information.

– Interest payment: U.S. savings bonds are zero-coupon bonds that accrue interest and compound semi-annually for 30 years. Thereafter, they no longer generate interest. Interest is electronically deposited to the bondholder’s designated bank account.

– Early redemption: Bonds mature between 15 and 30 years, and bondholders must wait at least 12 months before redeeming them. Redemption within the first five years incurs a penalty of three months’ interest. After five years, no penalty is imposed.

– Tax consequences: Interest earned from savings bonds is exempt from state and local income taxes. Federal taxes only apply when the bond matures, is redeemed, or after 30 years when it stops earning interest. Using bond proceeds for higher education tuition may exempt them from higher taxes.

Types of U.S. Savings Bonds

Presently, two types of U.S. savings bonds can be purchased electronically: Series EE and Series I.

– Series EE U.S. Savings Bond: Replacing the Series E bond in 1980, these bonds are sold at face value and are fully redeemed at maturity. They offer a fixed rate of interest, paid at maturity or redemption.

– Series I U.S. Savings Bond: Introduced in 1998, these bonds also sold at face value. They offer an interest rate adjusted for inflation, making it somewhat variable. The bonds guarantee a minimum interest rate of 0.00% during periods of deflation.

– Series HH bonds are no longer available for purchase. The U.S. government discontinued them in 2004. Matured bonds continue to receive interest payments. The Series HH bond was a 20-year, non-marketable savings bond issued by the U.S. government.

Other Considerations

To purchase or redeem U.S. savings bonds, an investor must be a U.S. citizen, official U.S. resident, or U.S. government employee.

U.S. savings bonds are among the safest types of investments, endorsed by the federal government and risk-free. While they do not earn as much interest as the stock market, they offer a less volatile source of income. Saving for future expenditures is possible as bonds cannot be cashed until at least 12 months after purchase, accruing more interest the longer they’re held.