What are Savings Bonds?: How it works?

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What are US Savings Bonds?
Letterpress blocks spell out the word "Bonds" as they rest on top of a $5,000 US Treasury I bond.

A U.S. savings bond is a government bond offered to its citizens to fund federal spending and provides savers with a modest but guaranteed return. These bonds are issued with a discounted zero coupon with an implied fixed interest rate for a fixed period of time.

Series EV savings bonds are sold at 50% of their face value and mature to full value after 20 years.

Key Takeaways

  • U.S. savings bonds are a type of government debt issued to American citizens to help finance federal spending.
  • Savings bonds are sold at a discount and reach their full par value and do not pay regular coupon interest.
  • Series EE bonds are sold at half their face value and mature in 20 years. Series I bonds are adjusted for inflation.

Understanding US Savings Bonds

A U.S. savings bond is a common type of bond issued by a government agency to raise funds from the public in order to support capital projects and other operations needed to manage the economy. When the government sells bonds, it actually takes a loan from the public and promises to repay it at a predetermined date in the future. As compensation for providing 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. These bonds are neither easily transferable nor transferable.

History of the US Savings Bond

In 1935, during the Great Depression, President Franklin D. Roosevelt signed into law a law allowing the U.S. Department of the Treasury to issue Series A federally-backed savings bonds. It was called Defense Bonds. After the attack on Pearl Harbor, these were called War Savings Bonds, and the money invested in them went directly to the war effort.

After the war ended, Americans were encouraged to buy savings bonds, providing a way for individuals and families to earn a return on their investment while enjoying the absolute guarantee from the United States government.

Characteristics of US Savings Bills

  • Non- marketable: U.S. savings bonds are designed to be non-marketable, meaning an investor can only buy the bond directly from the U.S. government and not sell it to another investor. The bond is not actually transferable, as it represents a contract between the investor and the U.S. government. This direct relationship ensures that the value of US savings bonds does not fluctuate. Therefore, if an investor buys back the bond, he will receive his original investment. Also, a savings bond certificate that is lost or damaged because the bond is registered with the government can be reissued or replaced.
  • Purchase: An investor can purchase bonds in penny increments with a minimum investment value of $25 and a maximum value of $10,000. A bond investor can be purchased and redeemed electronically through a TreasuryDirect website. 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 pay no interest until redeemed or maturity date. Interest is compounded semiannually and accrued annually for 30 years. After a bond is held for 30 years, it will no longer pay interest to the investor. An investor who purchases the bond at the end of the month will receive accrued interest for the entire month. Any interest paid on the redemption or maturity date is issued electronically to the bank account designated by the bondholder.
  • Early pay off: The time it takes for a bond to mature varies, but is usually between 15 and 30 years. A bondholder must wait at least 12 months after his initial purchase before using the savings bond, at which point he will receive the face value plus interest. In addition, investors who buy back the bonds within the first five years of purchase will forfeit the last three months’ interest as a penalty. However, retrieving a bond after holding it for five years does not result in any penalties.
  • Tax consequences: Interest earned on savings bonds is exempt from state and local income taxes. However, federal taxes do apply, but only after the year the bond matures, redeemed, or 30 years after the bond stops earning interest. If the investor uses the proceeds from the bond redemption to pay for higher education tuition, he or she may be exempt from high taxes.

Types of US Savings Bonds

There are currently two types of US savings bonds that can be purchased electronically: Series EE and Series I bonds.

  • EE Series US Savings Bond: The EE Series 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 that is paid at maturity or redemption.
  • Series I US Savings Bond: Series I savings bond was introduced in 1998. Like Series EE bonds, Series I is sold at par. These bonds offer inflation -adjusted interest rate, making the interest rate somewhat volatile. If inflation rises, the savings bond interest rate will be adjusted upwards. During periods of deflation, bonds are guaranteed never to fall below 0.00%.
  • HH series bonds can no longer be purchased. The US government discontinued these bonds as of August 31, 2004. Bonds that did not mature continued to receive interest payments. The HH Series bond was a 20-year, non-marketable savings bond issued by the U.S. government.

Other Considerations

To purchase or redeem a US savings bond, an investor must be a US citizen, official US citizen, or US government employee (regardless of citizenship status).

U.S. savings bonds are among the safest types of investments, as they are approved by the federal government and are therefore risk-free. Although these bonds do not earn as much interest compared to the stock market, they do offer a less volatile source of income. They provide a way to save for future expenses, as they won’t be able to cash out for at least 12 months after purchase, and the longer you wait to cash the bond, the more interest accrues.

When should I consider a savings bond?

A savings bond may be considered for investors who want to avoid risk and have a long time frame for repayment. You can also give a bond to loved ones, including children, or donate to someone with inheritance money. But savings bonds are not part of investment or bank accounts and are not useful for short-term savings goals.

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