How Do Savings Bonds Work?
Posted by Frank Gogol
If you are into finances and are looking for an investment where you can get a fixed income, then savings bonds are the best choice. These bonds are guaranteed by the government and are also easy to invest in. There is no need to shy away from investing due to the supposed high initial investment rates, as you can start small with savings bonds.
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What Exactly Are Savings Bonds?
A savings bond is a bond guaranteed by the government to invest with a low entry amount. They pose minimal risk and can act as your long-term investment plans. You do not need to be a financial expert or a regular high-income earner to invest in a savings bond. These bonds were designed to be non-marketable, meaning they can only be bought by the investors directly from the government and cannot be sold to anyone else.
US savings bonds can be called debt securities issued by the United States Department of Treasury. It’s a move made by the government to raise funds for its projects and expenditures. By buying a savings bond, you are lending money to the government. These can even be gifted to individuals and help finance their education, retirement plans, or business ventures.
How Does A Savings Bond Actually Work?
When you buy a savings bond, you are lending money to the government. When someone loans someone money, the person in debt pays the loaner a certain interest rate. In the same way, the government will pay you some money for the loan. Now you will receive returns on the amount you have invested or put in to buy the bond. The interests will increase your gain, and as time passes, you will receive more interest.
- You can buy savings bonds directly from the government on various investment platforms and websites.
- US savings bonds can be bought on the US Department of Treasury website as they no longer allow the physical paper bond to be sold by institutions and banks as of 2012.
- As time passes, the initial amount you have invested will gain interest
- You can redeem or withdraw your savings bond after the maturity period has crossed, and the interests that your money has acquired will also be added to the initial amount and given to you as the profit.
- There will be instances where you would want to make a premature withdrawal of your bond, but that comes with specific regulations
Different Types Of Savings Bonds
The US government has issued many types of savings bonds. Almost 13 types. These bonds are differentiated from each other in the way they pay the interests. Right now, the main ones in use are the following:
Series E Bonds
They are the oldest bonds. They were called war bonds or defense bonds. They were used to fund the government during the 2nd world war. These were converted into savings bonds after the end of the 2nd world war. They initially had a face value from $18 to $10,000 and a maturity period of 10 years. They were sold only on paper. They paid around 3.9 to 4.9% interest.
Based on the year the bond was taken and the denomination at that time, they could be worth around four to eight times their initial face value. According to the US Treasury, though, all series E bonds have reached the final maturity and no longer earn interests. The term of maturity initially was 10 years, but depending on the issue date and interest, the extension of 30 to 40 years was granted.
Scenario example – A series E bond brought in 1980 reached its final maturity in the year 2010. If the initial value buyers put in was a thousand dollars, then the final value they got after the maturity period would be around four thousand dollars.
Series EE Bonds
They came after world war 2 and were called Patriot Bonds. They are still in action and can be purchased, but not in paper form. They are relatively low-risk bonds. The minimum term of ownership is 1 year, and the interest-earning period is about 30 years.
The minimum investment requirement for series EE bonds is $25. Series EE bonds issued between May and October 2021 will earn a minimum interest rate of 0.10%. The Series EE bonds come with a promise from the government that they will double in value in 20 years. You can either withdraw that amount or let it earn interest for another 10 years. If you want to cash in early, it can only be done after at least 1 year is completed, and the additional interests earned on that amount will not be redeemable.
Scenario example – A $50 series EE bond can be bought at half its face value, that is $25. It will reach its complete face value in 20 years, and you will be able to earn interest for 30 years since the commencement of the bond.
Series I Bonds
Series I bonds are newcomers and are issued for 30 years. The plus point is that they have an inflation-adjusted profit rate. The adjustable rate is revised semi-annually in May and November.
The current interest rate on Series I bonds is 3.54%, from which every six months, a portion is indexed to inflation. The minimum holding period is one year, and the terms on premature withdrawal are the same as the series EE bonds.
How To Redeem Savings Bonds?
Paper bonds no longer exist, but if you want to cash an old paper bond, you need to take them to the banks or financial institutions. A limited amount of money will be cashed in, according to the rules of the banks. Usually, below $1000 is the cashing amount per one time.
Electronic or online bonds can be readily cashed through many websites or the official website of the US Treasury. As per the details regarding premature withdrawal, they have already been discussed above.
In the case of a deceased owner, you have to submit legal proof that the owner has allowed you to cash the bond.
Are Savings Bonds Good Investments?
It all depends on how long you are willing to wait to see the profits and how much you are investing. In any investment, positive returns are seen only after quite an amount of time.
- Savings bonds have a relatively low initial investment threshold. You can start small.
- Savings bonds come directly under the government, so there is no third-party play.
- As these bonds are a form of loan to the government, there won’t be any major losses.
- They offer certain tax advantages under specific conditions.
- A very effective way to have money stocked up for your retirement.
- Passive way of earning. Unlike stocks, you do not regularly need to trade your investments for profits. Therefore, you do not need to keep adding money each month too.
- The main disadvantage is that they have low returns. So the amount of profit you see at the end of 30 years may not seem so pleasing to you.
- Early redemption penalties. You can’t withdraw whenever you want. You need to wait a year, and even after that, there are penalties (as discussed above)
- Not a quick profit method. You will not see impressive returns or profit till at least 5 to 10 years have passed.
- Cannot be transferred to any other person except the investor.
- Tax benefits are only under special circumstances. Otherwise, the taxing procedure is normal, and income tax will apply to these bond incomes.
So, the savings bonds do give good profit. But only if you have the patience to wait for a whole lot of years. They don’t ask for your money each month, so you can invest once and sit back as the interests keep growing. At the end of the day, it is up to you to be happy with the returns they provide and if you want to buy a savings bond.