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How do Savings Bonds Work

Parul Solanki Jan 26, 2019
Saving bonds are issued by the United States Treasury Department to provide finance for the US government. In return, the government pays an interest rate to the holders of this non-transferable security. Read on to know more about how these bonds work.
You might have heard of it being given as gifts to children or used to save for college education bills. However, how many of us truly know what saving bonds are and how they work?

What are Saving Bonds?

Saving bonds are securities that are issued by the United States Treasury Department and offered at major banks and credit unions. For us, it may be the safe means of investing our hard-earned money.
However, saving bonds are used primarily for funding the dollars for the US government. In return, the government pays you interest for the investment, based on the denomination of the savings bond. It is important to note that saving bonds are not transferable or marketable.
They cannot be bought or sold by any organization or person other than the United States Treasury. After a specified holding period or post maturity, these registered securities can then be encashed. There are essentially two types of savings bonds issued, the EE savings bonds and the I bonds, which are the newer version of savings bonds.

What is the Interest Rate of Savings Bonds?

Interest rates of the savings bonds may differ based on the fluctuation of the economic interest rates. The value of the bond may differ based on the kind of bond purchased and when it is cashed. For example, the EE bond, that replaced the earlier Series E bonds, are sold at a 50% discount of the face value.
The interest is accrued each month and is stopped after thirty years. Unlike the I bonds where the redemption value never decreases, EE bonds if encashed before five years, incur a three month penalty. The current interest rates for the saving bonds are displayed on the U.S. Treasury website. This is updated on May 1 and November 1 every year.

Is there a Tax Advantage?

Saving bonds are subject to Federal Income taxes. However, the holders of saving bonds may pay the income tax annually, or defer the tax until the bond matures or the bond is cashed out. Also, there are no state and local taxes imposed on the saving bonds.
One other advantage of saving bonds as an investment is that there is no income tax levied on the bonds if used for higher education. Known as Educational Tax Exclusion or Educational Savings Bonds, these instruments can help you exclude the income from the taxes. However, the higher education claims need to be qualified at the time of redemption.

How Safe are the Investments?

Backed by the US government, the saving bonds are an appropriate low-risk financial instrument. Before you invest in these bonds, you need to keep certain things in mind. Although the interest rates might be higher than savings accounts, bonds do have a number of disadvantages.
  • The interest rates are quite low as compared to other long-term investments like stocks.
  • There are liquidity concerns where penalty is charged if the investment is withdrawn before five years.
Knowing how saving bonds work can help you make better decisions about investing in these securities. If security and long-term safety is what you are looking for and your entire motive of investment is to keep the principal amount safe, then this investment option should work great for you.