US Savings Bonds 101

Why These “Un-Sexy” Investments May Be Right for You

US Savings Bonds 101
March 19, 2014

It is rare that you see anyone on a financial channel screaming about investing in U.S. savings bonds, probably because they are not a very "sexy" investment and therefore don't make for good television. They may not be sexy investments, but they are solid investments – and they probably have a place in your portfolio.

Savings bonds have changed over time, and several types of savings bond are no longer issued. For purposes of this article, let's consider the two styles of savings bond that are currently available. Both have an interest-bearing period of 30 years.

  • Series I – These bonds are sold at face value and are redeemed for face value plus the accrued interest. The interest you receive is partly a fixed component and a variable component indexed for inflation based on the Consumer Price Index (CPI).

    Series I bonds are sold electronically through www.treasurydirect.gov. Paper Series I bonds are still available, but only by designating your tax refund to their purchase.

  • Series EE – These bonds have changed significantly. The old paper bonds used to be sold at discount (half of face value), and were redeemable for full face value at the end of the 30-year life. Paper bonds are no longer available, and the electronic bonds work a little differently.

    Electronic bonds are purchased at face value. They accrue interest at a fixed rate, and are guaranteed to reach twice their face value after 20 years. If the interest rate does not accomplish this on its own, the Treasury will make a one-time adjustment on the 20-year anniversary to fill the gap. That means you can get more than 3.5% interest… but only if you commit to holding the bond for two decades. The bonds will continue to accrue interest for another ten years at a potentially different fixed rate of return.

Both types of bonds may be redeemed at any time after one year from the purchase date. However, redeeming before the five-year anniversary results in a penalty of three months of accrued interest. After the five-year mark, you can redeem at any time without penalty.

U.S. savings bonds have the following advantages:

  • Taxes – The accrued interest is federal tax–deferred until the bond is redeemed. Interest on savings bonds is exempt from state and local taxes, so if you live in a high-tax state, savings bonds are a decent alternative to checking and savings accounts. If they are only used for higher education, the interest is exempt from federal income tax as well.

  • Competitive Interest – Interest on savings bonds is accrued monthly and compounded semi-annually, giving them a nice relative growth rate.

  • Stability – Savings bonds are fully backed by the U.S. government. You cannot possibly lose your principal.

  • Convenience – They are simple to buy online, and may be bought for a minimum of $25 at any value down to the penny.

  • Liquidity – Most banks can redeem paper bonds, and electronic bonds are redeemed online and directly credited to a checking or savings account.

Current rates are announced in May and November of each year; they set the rates for all of the bonds issued in the subsequent 6-month period.

The purchase limits for bonds are $10,000 per each type of electronic bond per year, plus an extra $5,000 in paper Series I bonds if you have the tax refund money available.

The combination of tax-deferred interest growth and ready liquidity make savings bonds attractive to higher income families; the stability along with the low minimum purchase levels make savings bonds attractive to lower income families, and the convenience and generally competitive interest rates make them attractive to everyone. Maybe not sexy… but attractive and solid.

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