What to know about savings bonds - securities you can buy from the US Treasury
savings bondis a debt instrument that's distributed and backed by the US government.
- The federal government issues two types of savings bonds: Series EE and I
- Series EE bonds double in value if held for at least 20 years, while I bonds keep pace with inflation.
A savings bond is a debt security you can buy from the US Treasury. Both types of savings bonds - Series EE and Series I - are "zero coupon," which means they pay interest only when they're redeemed.
Savings bonds tend to offer low returns, but "they are extremely low-risk as they are backed by the US government," says Michael James Kelly, Certified Financial Planner, CFA, and owner of Switchback Financial.
This type of investment could be a good fit for a long-term portfolio in some cases, but you should know about what they earn, how they're taxed, and how to buy them.
Series EE vs. Series I
When you buy a savings bond, you're essentially lending money to the US government, which promises to repay you within 30 years. The main difference between the two types of savings bonds is how the interest works:
- Series I bonds are designed to protect your money from losing value due to inflation. The annual interest rate is made up of two parts: a fixed rate and an inflation-adjusted rate that's calculated twice a year. If deflation occurs, the interest rate won't drop below zero.
- Series EE bonds are guaranteed to double in value if you hold them for at least 20 years. These earn a fixed interest rate, though Series EE bonds purchased before May 2005 have either a variable or fixed rate, depending on the issue date.
Quick tip: Electronic savings bonds are sold at face value, and you can buy them in penny increments from $25 to $10,000 every calendar year. To get the maximum value of a savings bond, you'll need to hold it to full maturity.
"EE bonds, at least right now, are best suited for long-term investors," says Jeremy Keil, a Certified Financial Planner, CFA, and owner of Keil Financial Partners. "If you are shorter-term and think you'll cash out in the next one to five years, you'll probably do better with I bonds. I bonds are also guaranteed to keep up with inflation, and very few investments are guaranteed to do that."
Series bonds rates and taxation
Once you purchase a savings bond, interest is credited every month and compounded twice a year. Rates on new bonds change every April and November, and series I bonds also have semiannual rate changes. You can find these rates and their changes directly from the TreasuryDirect website.
Quick tip: Savers can cash in a bond after holding it for at least one year. But penalties kick in if you redeem a savings bond within five years of buying it. You'll lose three months' worth of interest, plus whatever the bond would have earned through maturity.
Savings bond investors pay federal taxes on interest earned, but not state or local income tax, says Mark Steber, the chief tax information officer at Jackson Hewitt Tax Services. You have a choice on when to pay those taxes, though.
"Taxpayers can choose to pay taxes on the interest increase for each year when filing that tax return," Steber says, "or they can pay taxes when the bonds are cashed in or reach final maturation date."
The decision typically comes down to the individual and their own tax situation. But generally, "I think that waiting is the best option," Kelly says. "You can benefit from investing that money that could be used to pay taxes annually and gain from the time value of money." However, if you expect your federal taxes to be higher at a later date, then it may make sense to pay taxes as interest is earned.
Quick tip: If you redeem a bond and use the money for qualified education expenses in that tax year, the interest you earn is tax-free. To qualify for the exclusion, your adjusted gross income must fall below $97,350 (or $153,550 for joint filers).
Whether you have to pay taxes also depends on who bought the bond, who owns it, and sometimes where you live. Check out this table to see which situation applies to you:
|Situation||Who owes the tax?|
|You buy a bond for yourself.||You|
|You buy a bond for yourself and a co-owner.||You|
|You buy a bond for someone else and put it in their name as owner.||The person named as owner.|
|You and another person buy a bond together and are named co-owners.||You and the co-owner each report the interest in proportion to how much you each paid for the bond.|
|You and your spouse file separate federal income tax returns. You live in a community property state and buy a bond that is community property.||You and your spouse each report one-half of the interest on your federal income tax returns.|
Pros and cons of savings bonds
Like any financial investment, savings bonds come with some benefits and drawbacks. Consider these points before taking out a savings bond:
|They're low risk. If you keep the bonds until maturity, you're guaranteed to get back the entire principal amount plus interest.Electronic savings bonds are sold at face value, which means you won't pay extra fees on the investment. The earned interest is subject to federal income taxes but not state or local income taxes. You can choose to defer taxes until you redeem the bond. And you might qualify for a tax break when using bond funds to pay for higher education costs.||You won't receive the maximum return until you redeem the bond, which is typically 30 years. Cash in the bond early, and you pay a penalty.There's a purchase limit of $10,000 in bonds of each series (so $20,000 total) in any one year, plus another $5,000 for paper I bonds.Savings bonds have a low yield compared to a more aggressive investment.|
How to buy savings bonds
All savings bonds used to be issued on paper slips, but now savers have two options:
- Buy online. You can purchase bonds electronically at TreasuryDirect.gov, the US Treasury's electronic savings portfolio platform. Once you open an account, you'll choose the type of bond you'd like to buy and the denomination. Both are available in penny increments between $25 and $10,000. Your online account is where you can go to track your bonds' growth, make purchases, and reinvest.
- Buy paper: You can purchase an additional $5,000 in paper I bonds using your IRS tax refund when you file your annual income tax return.
Once you have the bond, you decide how long you'll hold onto it, anywhere between one and 30 years. EE bonds double in value after 20 years - but you'll need to wait the full term to get the maximum return on either type of bond. Cash in before that point, and your return will be based on a maturation schedule that rises over the course of the bond's term.
The financial takeaway
Savings bonds provide a safe haven for your money since they're backed by the US government. While Series EE bonds double in value if you hold them for at least 20 years, Series I bonds could be more beneficial if inflation continues to rise while savings rates stay low.
"Instead of keeping mid-term cash in a savings account or CD," Kelly says, "one could hold the money in a Series I bond and hedge against inflation while getting a higher rate."
Either way, both types of bonds are typically seen as a long-term investment - so consider including these in your portfolio if you have time to let them fully mature.What is hyperinflation? Understanding the rapid increase in the cost of goods and services over timeBonds can be taxable or tax-free - here's your guide to the different types and calculating what's due on themBonds vs. CDs: The key differences and how to decide which income-producing option is better for youBonds can be taxable or tax-free - here's your guide to the different types and calculating what's due on them
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