Banking » Investing » How Do Savings Bonds Work?
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How Do Savings Bonds Work?

Savings bonds are issued by the U.S Department of Treasury and offer safe, low risk investment. Most bonds have a maturity of 10 to 30 years
Author: Lorraine Smithills
Lorraine Smithills

Writer, Contributor

Experience

Lorraine is a freelance finance writer with years of experience in the banking sector and after a successful career in one of the largest retail and commercial financial services providers. She has a passion for helping people with less financial confidence to get control of their money through budgeting, saving, and responsible credit practices.
Interest Rates Last Update: April 15, 2024
The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.
Author: Lorraine Smithills
Lorraine Smithills

Writer, Contributor

Experience

Lorraine is a freelance finance writer with years of experience in the banking sector and after a successful career in one of the largest retail and commercial financial services providers. She has a passion for helping people with less financial confidence to get control of their money through budgeting, saving, and responsible credit practices.
Interest Rates Last Update: April 15, 2024

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Table Of Content

What Is A Savings Bond?

Savings bonds are a low risk investment that can be part of your long term investing strategy. These bonds are guaranteed by the government and offer a low entry point, with a non marketable asset that cannot be sold to someone else and can only be purchased from the government.

Savings bonds are issued by the U.S. Department of Treasury and may also be called debt securities. The government uses savings bonds to raise funds to cover expenditures and projects. So, by buying a savings bond, you are essentially lending money to the government. There is little risk, as the only way you will lose your initial investment is if the government fails.

The main catch is that you are tying up your funds for a significant period. Most bonds have a maturity of 10 to 30 years, with no way to liquidate your funds if you have a financial emergency.

While you can purchase savings bonds for yourself, you can also use them to gift to others. You could buy a savings bond for your child to help fund their education or contribute to the set up costs for a business venture in the future. 

How Do Savings Bonds Work?

Savings bonds are essentially like a loan to the government. As with most types of loans, you'll receive interest from the Treasury Department when you lend money to the government, similar to investing in other U.S. government bonds.

The bonds pay interest, and your earnings accrue and compound over time. However, unlike other financial products, you won't receive any interest during the bond's lifetime, as it will not be paid out until you redeem it.

You can purchase bonds in almost any amount, from $25 to $10,000. Most bonds are now issued electronically, but some paper bonds were still limited to specific denominations, including $50, $100, $500, and $1,000.

However, paper bonds are more tricky, as they can be lost, destroyed, or stolen. If you have a paper bond that is lost or mutilated, you would need to request a replacement, which would be issued as an electronic bond.

Savings bonds are very similar to stock investing, but since they are government-backed, they carry less risk. You simply need to wait until the bond reaches maturity, and then you'll receive the value of your bond plus the accrued interest.

savings bonds series i and series ee
(Photo by Jonathan Weiss/Shutterstock)

The Types of U.S Savings Bonds

Over the years, the U.S government has issued a number of types of savings bonds. These bonds differ from each other in the interest offered and specific terms. The current saving bonds on offer include:

These bonds were originally called Patriot Bonds as they were introduced after World War II. Despite this initial release, EE bonds are still in action and you can purchase them electronically. These bonds offer a term of one year to 30 years.

The minimum investment for EE bonds is $25, but the interest rates vary according to when the bonds are issued. For example, for bonds issued in 2021, between May and October, the minimum interest rate was 0.1%. However, the current rate is now higher. Series EE bonds come with a government promise that they will double in value within 20 years.

At this point, you could withdraw that amount or allow the bond to continue earning interest for a further 10 years. If you do want an early cash-in, you need to wait at least one year and any additional interest earned on the amount will not be redeemable.

For example, if you bought a $100 EE series bond, it would cost you $50 and it would reach a $100 value in 20 years. You can then earn interest for a full 30 years until the bond matures.

These are a relatively new offering and are issued with a 30-year term. However, these bonds have inflation-adjusted profit rates, with the rate revised in May and November each year. 

The minimum holding period is one full year, with the premature withdrawal terms being the same as with EE Series bonds.

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How to Cash in Savings Bonds?

The current EE and I savings bonds can be cashed in after one full year, but if you cash in before the bond is five years old, you will forfeit the last three months of interest. These bonds earn interest for up to 30 years and the longer that you hold the bond, the more interest it will accrue.

When you’re ready to cash in, how you go about it will depend on whether you have a paper or electronic savings bond.

  • You can redeem paper savings bonds at most bank branches or credit unions. You can then pay the funds into your chosen bank account or draw some in cash.
  • If you have an electronic bond, you can sign into your account on the TreasuryDirect website and then follow the instructions after you click to redeem your bond. The cash value of your bond will be credited to your savings or checking account within two business days.

There is a minimum redemption of $25 if you have an electronic bond, but there are typically no limits when you cash in a paper bond. However, the bank where you’re cashing the bond may have restrictions for how much you may redeem at any one time.

Savings Bonds Pros and Cons

As with all financial products, there are both positives and negatives associated with savings bonds. It is important to be aware of these points to make an informed decision.

Pros
Cons
Low Minimum Investment
Low Returns
Direct From the Government
Redemption Penalties
Tax Incentives
No Transfers
Passive Earnings
Special Circumstances Tax Benefits

Savings bonds typically have a low initial investment, so you can start with a small amount and purchase higher value bonds later.

Since the bonds are issued directly from the government, you don’t need to worry about third parties or investment risk. You can feel confident that you won’t suffer any major losses.

Under certain conditions, savings bonds may offer some tax advantages.

 Unlike investing in stocks, you don’t need to trade to optimize the profits regularly. So, you don’t need to manage your investment or keep adding money every month actively.

The main downside to savings bonds is that they offer low returns compared to other investment options. 

While they may offer a good rate compared to standard savings accounts, it may not seem so great when you consider that you need to tie up your money for up to 30 years.

This follows on from the previous point, but you can’t simply withdraw your funds as and when you want them. 

You will need to wait at least one full year and even then you are still likely to incur an early redemption penalty.

You cannot transfer your savings bond to anyone else. Only you will be able to redeem the bond when it matures.

Although there are some tax incentives, these will only apply under special circumstances.

 In most cases, income tax will apply to any interest that your savings bond accrues.

How to Buy Savings Bonds

The only place to purchase EE series savings bonds is via the TreasuryDirect.gov website. This is the official Treasury website. You’ll need to set up an online account and link it to your bank account.

You’ll need to be 18 or older, a U.S citizen or resident and provide your Social Security Number. You can then buy electronic savings bonds. The minimum purchase is $25, with a maximum of $10,000.

The purchase process is slightly different if you are interested in Series I bonds. While you can buy them electronically, as detailed above. However, you can also buy paper bonds using your tax refund with a maximum purchase amount of $5,000. To do this, you will need to complete an IRS Form 8888 and file it.

Savings Bonds as Gifts

If you want to give a savings bond to someone as a gift, the simplest way is to purchase a Series I paper bond. When you file your tax return, you can designate the amount of your refund you would like to receive as a savings bond. In this way, you don’t need to have the recipient's information, as you can give the paper bond as you would cash.

Fortunately, you don’t need to wait until tax season to gift a savings bond. You can also purchase an electronic bond to give to someone. You will need to have some details for the recipient, including:

  • Their full name
  • Their Social Security Number or a TIN
  • TreasuryDirect account number

Buying a savings bond to give as a gift follows the similar process to if you were to buy it for yourself. Just bear in mind that electronic bonds are tied to the recipient’s Social Security Number. Once it is gifted to them, it cannot be traded or exchanged.

How to Maximize Savings Bonds

While savings bonds are quite a straightforward investing option, there are some tips that can help you to maximize your investment.

Savings bonds pay interest for up to 30 years, but the longer that you hold the bond, the better the return. So, don’t plan to cash in your bond after a year or two.

Remember that you'll face an interest penalty if you redeem your bond within the first five years.

This is one area where savings bonds really shine. EE series bonds are guaranteed to be worth twice the purchase amount if you hold them for 20 years. 

This works out to a decent yield, particularly since this is a low risk investment product.

If you are concerned about hedging against inflation, you’ll need to think carefully about your savings bond options. EE series bonds don’t have inflation protection. However, Series I bonds have a fixed base rate plus an inflation rate calculated twice per year. 

So, if inflation protection is more important to you than a “doubling” guarantee, Series I saving bonds will be better for you.

maximize Savings bonds
(Photo by larry1235/Shutterstock)

Savings Bonds vs Savings Accounts: Main Differences

If you’re unsure whether you should purchase a savings bond or put your money into a savings account or a certificate of deposits, there are some key factors you’ll need to consider.

  • You’ll need to hold savings bonds for at least one year.
  • Savings bonds may incur an early redemption penalty.
  • Savings bonds offer a higher rate of return if you hold it for at least 20 years
  • Savings accounts offer liquidity, even with a high-yield savings account, you can withdraw up to six times per month without penalty.
  • Savings accounts have federal insurance should the financial institution fail, up to $250,000 per account holder.
  • Some savings accounts may have minimum balance requirements.
  • Some savings accounts have monthly maintenance fees or charges.

FAQs

The easiest way to buy a savings bond for your child is to use all or part of your tax refund and purchase a series I paper savings bond.

We’ve detailed the process above, but you’ll need to designate the amount when you file your tax return or file an IRS Form 8888.

Most banks allow you to cash paper savings bonds, but it is best to use a bank where you hold an account. The bank may have restrictions on how much you can cash at any one time, and you may need to provide ID.

Unless special circumstances apply, yes you’ll need to pay income tax on the interest earned on your US savings bond.

Follow the process we’ve detailed in the article above. You can purchase paper series I bonds or electronic EE bonds. In most cases, you will need to have recipient details to be able to gift a savings bond.

POD refers to payable on death. This means that the savings bond can be transferred without probate if they are named as a POD beneficiary to inherit them.

The serial number for your savings bond is found in the lower right hand corner of the paper bond. It is a good idea to keep a note of this number, as you’ll need it should your savings bond be destroyed or lost.

The U.S Treasury Department has a database on the TreasuryHunt.com website. This allows you to provide your social security number to see if you have any savings bonds linked to you.

This depends on your investment goals and your strategies. If you’re looking for a low risk, long term investment, savings bonds can be a good idea. However, if you’re looking for a quick return, you’ll need to consider other assets.

You can redeem a paper savings bond at your bank. Most banks will allow you to cash in a paper savings bond, but fees may apply and you may be restricted to a maximum amount at any one time.

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Picture of Lorraine Smithills

Lorraine Smithills

Lorraine is a freelance finance writer with years of experience in the banking sector and after a successful career in one of the largest retail and commercial financial services providers. She has a passion for helping people with less financial confidence to get control of their money through budgeting, saving, and responsible credit practices.
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