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When investors want to earn income while also diversifying their portfolios, they often turn to bonds to add a layer of safe, conservative assets to their holdings. Specifically, that often entails buying savings bonds from the United States Department of the Treasury because of their low risk and predictable gains. Additionally, savings bonds can act as a hedge for asset classes that are more prone to market volatility and economic downtowns, such as stocks, exchange-traded funds (ETFs) and mutual funds.
Read on to learn about what savings bonds are, their pros and cons, the different types available and whether or not they are a good fit for your investment strategy.
What is a savings bond?
A savings bond is a type of bond issued by a government and sold to the general public in order to raise funds or investments for public services. Specifically, U.S. savings bonds are debt securities issued by the Department of the Treasury that are used to help pay for the federal government's operating expenses.
Importantly, U.S. savings bonds are considered one of the safest investment vehicles available because they are backed by the full faith and credit of the federal government, which to date has never defaulted on its debt obligations. Savings bonds are also very predictable investments, with set terms that offer unsurprising yields.
To help determine how much money you can make by investing in them, the U.S. government offers a savings bond calculator through the Treasury Department’s online portal, TreasuryDirect.gov.
How do savings bonds work?
In essence, savings bonds are loans provided to the government that earn the purchaser interest. Savings bonds issued by the Treasury Department have maturities of 30 years, with interest that compounds biannually. U.S. savings bonds can be redeemed after one year, but if they are cashed in before five years, the bondholder will sacrifice some of the interest accrued.
When the savings bond reaches its maturity date, the bondholder can either redeem it for its face value — also known as the par value — plus any interest accrued, or leave it in the Treasury account to fund the purchase of additional savings bonds or Treasurys, like bills, notes and bonds.
Types of savings bonds
Since 1935, the U.S. federal government has offered numerous types of savings bonds, most of which have since been retired (e.g., Series A and Series E bonds). The Treasury Department stopped issuing paper savings bonds in 2011 (except for those purchased with a tax return). However, despite switching to electronic bonds, those who still hold paper bonds can redeem them at banks and other financial institutions.
Today, the U.S. Treasury only issues two types of U.S. savings bonds: Series I bonds and Series EE bonds. By using our guide to the best savings bonds, you can determine which type is the most appropriate for your personal investing needs.
To provide a clearer picture of the two types of savings bonds currently available through the Treasury Department, the following section provides details about each.
Series I savings bonds (aka I bonds)
As the “I” in its name implies, the Series I bond is designed to help investors protect their wealth from being eroded by inflation. That’s accomplished by offering both a fixed rate that lasts the lifetime of the bond’s term, as well as a variable rate that is adjusted twice a year depending on the current level of inflation as measured by the Consumer Price Index (CPI). The Treasury Department adjusts the variable interest rate for I bonds May 1 and Nov. 1 each year. If inflation is elevated, I bonds’ variable rates will reflect that. Conversely, when inflation cools, I bonds' variable rates tend to fall.
The maximum amount of electronic Series I bonds that can be purchased in one calendar year is $10,000, and they can be purchased in increments of $25. However, you can use your federal income tax refund to buy an additional $5,000 worth of Series I paper bonds (in $50 increments) each calendar year.
In order to buy paper savings bonds with your tax refund, you’ll have to use IRS Form 8888 to specify how much of your refund should be allocated to additional I bonds and how much should be sent to you directly via check or direct deposit. Additionally, on Form 8888, you must specify who the bondholder will be, meaning that you can use the paper bonds for yourself or gift them to someone else.
Early withdrawal penalties
You can redeem Series I bonds one year after their issue date, but if you do so before five years, as a penalty, you will forfeit the prior three months of interest. After five years, the bonds can be cashed in without any penalty.
Series EE savings bonds
Series EE savings bonds feature a fixed rate of interest for the first 20 years of the 30-year term. One of the most alluring features of EE bonds is that, within those first 20 years, the federal government guarantees that your investment will double in value. After the first 20 years, the interest rate may change. At that point, you can either redeem your EE bonds penalty-free or hold them for an additional 10 years until the date of expiration.
The maximum amount of electronic Series I bonds you can purchase in one calendar year is capped at $10,000, and they can be purchased in increments of $25. However, unlike Series I bonds, you cannot use your federal income tax refund to purchase additional Series EE paper bonds.
Early withdrawal penalties
Just like Series I bonds, you can redeem Series EE bonds after one year from their issue date, but if you do so before five years, you will forfeit the prior three months of interest. After five years, the bonds can be cashed in without any penalty.
Pros and cons of savings bonds
Like any type of investment, savings bonds have their share of advantages and disadvantages. The following section lists the major benefits and drawbacks of both Series I and Series EE bonds.
Pros of buying savings bonds
Low investment risk
As far as debt securities are concerned, savings bonds expose investors to some of the lowest risk levels possible. Because they are backed by the full faith and credit of the U.S. government, savings bonds can provide you with peace of mind knowing that your investment is secure and predictable, while also serving as a hedge for other assets in your portfolio that are more susceptible to market volatility and economic instability.
After holding them for one year, U.S. savings bonds are highly liquid. You can redeem them through the TreasuryDirect platform before their maturity dates, and if you have held them five years from the date of issue, you will not have to worry about paying early withdrawal penalties. In most cases, after cashing in your savings bonds, the money can be transferred from your Treasury account to your linked savings account or checking account in as little as two business days.
Interest compounded biannually
Both Series I and Series EE bonds begin earning interest from the first day of the month you purchase them, meaning if you buy them on the last day of a month, you’re given the entire month’s worth of interest. Both savings bonds accrue interest monthly. Every six months, that interest is compounded when it is added to the principal amount of the bond. This will occur twice a year until you redeem the bond or it reaches maturity.
Cons of buying savings bonds
Early withdrawal penalties
Both Series I bonds and Series EE bonds allow you to redeem them before their 30-year maturities. However, you must hold either type of savings bond for at least one year, and if you cash them in sooner than five years, you will sacrifice the last three months of interest accrued. If you do not want your funds tied up for at least one year, or don’t like the idea of forfeiting some of your accrued interest in order to access your money, savings bonds may not be the best choice of investment for you.
Lower interest rates than other investments
When it comes to investments, lower risk almost always equates to lower returns. Such is the case for savings bonds. Because of their considerable low risk and the fact that they are backed by the full faith and credit of the U.S. government, Series I and Series EE bonds do not offer the possibility of returns as substantial as higher-risk investments like stocks, options and futures can.
The tax situation is identical for Series I and Series EE bonds. Income generated from either is taxed at the federal level, but in most cases, they are not subject to state or local income taxes. For inherited savings bonds, beneficiaries may have to pay federal income tax if the executor of the estate doesn’t include the pre-death interest in the deceased’s final tax filing. Additionally, you may be subject to estate taxes if the amount received exceeds the federal or state estate tax thresholds if you live in one of 17 states that levy those taxes or the District of Columbia.
However, you may be able to avoid paying any taxes on savings bond income if those earnings are used for qualifying higher education expenses at an approved educational institution. To learn more, read “Using bonds for higher education” on the TreasuryDirect website.
How to buy savings bonds
The easiest way to buy savings bonds is directly from the U.S. Treasury. This can be done by creating a TreasuryDirect account, which will require information like your Social Security number, address and email. You can then link to your bank account and fund with the amount of debt securities you intend on purchasing. For both Series I and Series EE bonds, purchases made through TreasuryDirect are capped at $10,000 per calendar year.
Series EE bonds are only available as electronic savings bonds. However, if you are wondering how to buy paper I bonds, you can do so using your tax return. Paper I bonds are available in five denominations: $50, $100, $200 and $500 and are capped at $5,000 per calendar year. You must use IRS Form 8888 to specify the amount of paper I bonds you wish to purchase and the name of the bondholder.
How to cash in savings bonds
Savings bonds can be redeemed after one year from the issue date. For electronic I bonds or EE bonds, you can cash them in through TreasuryDirect. The funds can then be transferred to the bank account linked to your TreasuryDirect account in as little as two business days.
If you hold paper savings bonds — whether Series I or any discontinued savings bond series previously offered by the Treasury Department — they can be redeemed at your local bank or credit union. However, in order to cash in paper savings bonds, you may have to be an account holder at that financial institution.
Savings bonds vs. CDs
When interest rates are higher, savings bonds and certificates of deposit (CDs) are two attractive, low-risk investments. CDs are a type of high-yield savings typically offered by member FDIC banks and credit unions belonging to the National Credit Union Association.
When comparing CDs vs. bonds, you’ll see similarities. They both offer safety, predictable returns and fixed terms. Both are debt instruments and income securities. Furthermore, both savings bonds and CDs generally have early withdrawal penalties, though in the case of Series I and Series EE bonds, those penalties are waived after five years.
However, the two investments vary considerably. One way they differ is their rate structures. CDs offer fixed rates over the lifetime of the term, whereas interest rates for I bonds are adjusted every six months and EE bonds are adjusted after 20 years. Additionally, CDs are generally FDIC-insured or, if offered by credit unions, backed by the National Credit Union Association. This protects your investments up to $250,000. Savings bonds issued by the U.S. Treasury are backed by the full faith and credit of the federal government.
What is a savings bond FAQs
How long does it take for savings bonds to mature?
Do savings bonds have early withdrawal penalties?
How can I redeem my savings bonds?
Summary of Money's what is a savings bond
Savings bonds are a type of debt security offered by the U.S. Department of the Treasury. They offer a safe investment backed by the full faith and credit of the government. Series I bonds offer a combination of a fixed rate and a variable rate, the latter of which is adjusted biannually according to the latest inflation rate. Series EE bonds have rates fixed for the first 20 years, which can be adjusted thereafter for the remaining 10 years. Both types of savings bonds mature after 30 years, can be redeemed penalty-free after five years and offer reliable and reasonable interest rates.
Savings bonds have an early-withdrawal penalty and carry tax implications. In a low-interest-rate environment, investors may be able to find better yields in other asset classes. Like any investment, before purchasing, be sure to conduct your own due diligence to determine whether or not savings bonds are a good fit for your portfolio.