What are US Savings Bonds?

A US savings bond is kind of like lending someone a book…

If your friend Lisa wants to borrow a book, you might be willing to lend one to her that she’s been eyeing. Lisa will read the book and, when she finishes it, she’ll return it to you. As a thank you, your friend might buy you a small gift or new book to give to you when she returns the one you lent her. Similarly, buying a US savings bond is like lending something – money – to the US federal government. The government gives it back to you after a certain period, plus some extra money as a thank you for the favor.

US savings bonds are debt securities that people can buy from the federal government, through the United States Department of the Treasury. When the government needs to borrow money to fund its projects – like building roads – it does so by selling bonds. People who buy these bonds are lending their money to the government. In return, the government promises to repay the bondholders the original amount plus interest in the future.

Savings bonds differ slightly from other types of US government bonds. One major difference is that people who own savings bonds cannot sell them to other individuals. That is, they are non-marketable (aka cannot be traded) and only the original buyer (or a beneficiary in case of death) can redeem them through the US federal government.

There are also limits on how much you can buy. The minimum purchase is $25 and the maximum annual purchase for each type of US savings bond is $10,000. Today, there are two different types of US savings bonds available for purchase – Series EE and Series I.

Bondholders can redeem their bonds once they’ve owned them for at least a year. However, a penalty applies for redemptions made within five years of purchase – The last three months’ of interest are forfeited. Both types of US savings bonds stop earning interest after 30 years.

Interest on modern bonds compounds twice per year – This means that the interest you earn is added to the bond’s value and you start earning interest on the interest. However, you can’t get the interest paid out to you until you cash in on the bond.

US savings bonds are backed by the full faith and credit of the United States. Many investors interpret this to mean that there is almost no default risk (aka risk of not paying), making US bonds an incredibly safe investment.

The American government first began selling savings bonds in 1935 when President Franklin D. Roosevelt signed a law authorizing the sale of “baby bonds,” as they were popularly known. The US Department of the Treasury had sold bonds as far back as 1776, but these baby bonds were the first that bondholders couldn’t sell on the open market (i.e. trade) – Only the original purchaser could redeem them through the government.

In 1941, the government introduced Series E bonds to help pay for costs related to World War II. To help promote them, the Treasury introduced the Volunteer Program, which enlisted the help of bankers, executives, and celebrities to advertise these bonds to the nation. Originally, Series E bonds matured after ten years, but the government authorized extensions and continued paying interest on them for between 30 and 40 years.

The US government also established a system where workers could purchase savings bonds through payroll deductions, giving people the opportunity to automatically buy bonds from their paycheck.

Today, the government primarily sells two types of savings bonds: Series I savings bonds and Series EE savings bonds. Series EE bonds pay a fixed interest rate, while Series I bonds pay a split fixed and variable interest rate, based on changes in inflation.

Today, the US Department of the Treasury sells two types of savings bonds – Series I and Series EE savings bonds. Both are exempt from state and local income tax, but are subject to federal income tax in most cases.

With both types of bonds, you earn interest monthly, but it only compounds every six months (aka semiannually). When it compounds, the earned interest is added to the value of the bond and you’ll start earning interest on the bond’s increased value. You can only get the interest paid out to you when you redeem the bond.

Series I savings bonds pay a split interest rate, based on a fixed rate that is set when the government issues the bond and a variable rate based on inflation. This inflation rate is calculated twice a year using the Consumer Price Index, a commonly used metric that tracks the price of common household products.

The government sells Series I bonds at face value, which means that buyers pay $100 for a $100 bond. Bondholders earn interest based on that value.

The minimum and maximum purchase amount each calendar year depends on whether you purchase these savings bonds by paper or electronically. If you’re buying electronically through the government’s TreasuryDirect website, the minimum purchase amount is $25 and maximum is $10,000. However, you can still buy Series I bonds by paper (only when filing a federal income tax return) for a minimum of $50 and maximum of $5,000.

Bondholders can redeem Series I bonds after a year passes from the date of purchase. However, redemption is subject to a penalty equal to the previous three months’ interest if the bondholder redeems the bond within the first five years of purchase.

Series I bonds earn interest for up to 30 years after the purchase date.

Since May 2005, Series EE savings bonds have paid a fixed interest rate , meaning that the rate is set for the life of the bond at its issuance. Prior to that, the US government paid a variable interest rate on these bonds.

Buyers today may only purchase Series EE bonds electronically, either through the TreasuryDirect website or through payroll direct deposit. These bonds are also sold at face value, and the minimum purchase amount is $25 and maximum is $10,000 for a given calendar year.

Bondholders can redeem them after a year passes from the date of purchase. However, holders must pay a penalty of 3 months’ interest if they redeem them before five years pass from the original date of purchase.

Series EE bonds earn interest for up to 30 years after the purchase date – When you buy the bond, you know what rate it will earn for at least the first 20 years, but the fixed rate may change after that.

Savings bonds mature 30 years after the purchase date, which means they stop paying interest at that time. As long as one year has passed since the original purchase, bondholders can also redeem bonds before their maturity date. However, they stop paying interest immediately when you cash in on them.

If you currently have a paper US savings bond, you can calculate its value using the US Department of the Treasury’s tool for finding the value of paper bonds.

Assuming you don’t have a paper savings bond with a serial number sitting around, you can also use the compound interest formula to determine the value for fixed rate savings bonds (i.e. Series EE bonds).

The compound interest formula is as follows:

Original value * (1 + rate)number of periods = Current value

Let’s look at an example. If you have a savings account that pays 5% interest per year and you deposit $10,000, you can determine what the value of the account will be ten years from now using the compound interest formula.

$10,000 * (1 + .05)10 = $16,288.95

If your interest didn’t compound, you’d only earn 5% interest on your initial deposit of $10,000. That means you’d earn $500 per year ($10,000*.05), or a total of $5,000 in interest over ten years, instead of the $6,288.95 that you earned with compound interest.

Savings bonds stop earning interest after 30 years, at which point redeeming them typically makes sense. Redeeming them after they stop earning interest lets you use the money for something else, and you can possibly even reinvest it for continued returns.

Prior to the bond’s maturity, the decision for when to cash in a savings bond is a personal one. You may decide you need to cash in on a bond based due to an immediate need for money to cover an expense. Or, an opportunity may arise to invest the money in something that will offer a better rate of return (aka percentage growth of an investment over a certain time period).

To redeem electronic US savings bonds, you can log in to your TreasuryDirect account (run by the US Department of the Treasury) and redeem them there. The federal government can then transfer the funds directly to your bank account.

Cashing in on paper savings bonds usually happens at your local bank. Most banks can help you cash paper bonds – In fact, more than 95% of all US savings bonds get cashed at local banks and credit unions.

If you cannot locate a bank near you to cash your paper bonds, you can submit the savings bonds and form FS 1522 to the US government to request payment.

Whether US savings bonds are a good investment depends on your financial goals and needs.

Most investors see US savings bonds as among the safest investments available, which makes them appealing to people who want low-risk returns, such as retirees. However, savings bonds tend to offer lower returns than other investments, such as stocks or mutual funds.

Bonds, including savings bonds can play a vital role in your investment portfolio, but whether they are a good investment for you depends on whether you want lower, but potentially safer, returns, or higher, but riskier, earnings.