How Do Savings Bonds Work?
Posted by Frank Gogol in Investing | Updated on August 26, 2022
If you are looking for a fixed-income investment, then savings bonds are the best choice. These bonds are guaranteed by the U.S. government and are easy to invest in. There is no need to worry about any large initial investment amount, 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 with a low entry point. They pose minimal risk and can act as part of long-term investment plans. You do not need to be a financial expert or a high-income earner to invest in savings bonds. These bonds were designed to be non-marketable, meaning they can only be bought by investors directly from the government and cannot be sold to anyone else.
U.S. 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 interest 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.
- U.S. savings bonds can be bought on the U.S. Department of Treasury website as they no longer allow physical paper bonds 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 passed, and the interest your money has acquired will also be added to the initial amount and given to you as 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 U.S. government has issued many types of savings bonds—over a dozen types. These bonds are differentiated from each other in the way they make interest payments. Some of the current bonds include:
Series E Bonds
These are the oldest bonds. They were called war bonds or defense bonds. They were used to fund the government during World War II. These were converted into savings bonds after the end of World War II. 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 bought and the denomination at that time, they could be worth around four to eight times their initial face value. According to the U.S. Treasury, though, all series E bonds have reached their final maturity and no longer earn interest. The term of maturity was initially 10 years, but depending on the issue date and interest, the extension of 30 to 40 years was granted.
Sample scenario: A series E bond bought in 1980 reached its final maturity in the year 2010. If the initial buyer 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
These bonds came after World War II 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 one 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%. 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 one year is completed, and the additional interests earned on that amount will not be redeemable.
Sample scenario: 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 until the maturity date of the bond.
Series I Bonds
Series I bonds are newcomers and are issued for 30 years. The selling 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 for 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 a bank or financial institution. A limited amount of money will be cashed in, based on the rules of the banks. Usually, below $1,000 is the daily limit.
Electronic or online bonds can be readily cashed through many websites or the official website of the U.S. Treasury. The details regarding premature withdrawals have already been discussed above.
In case of a deceased bond-owner, you have to submit legal proof that the owner has allowed you to cash the bond.
Are Savings Bonds Good Investments?
Whether or not savings bonds are good investments 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 typically seen after a certain amount of time.
- Savings bonds have a relatively low initial investment threshold. You can start small.
- Savings bonds come directly from 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 great.
- 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 until at least five to ten years have passed.
- Cannot be transferred to any other person except the investor.
- Tax benefits are only under special circumstances. Otherwise, income tax will apply to these bond incomes.
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Savings bonds can provide good profit. But only if you have the patience to wait for a number of years. They don’t require your money each month, so you can invest once and sit back as the interest 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.
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