How Do Savings Bonds Work?

Photo illustration to accompany article on how to buy savings bonds ©Getty Images
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In times of volatility for the stock market, it’s reasonable that some investors might look for a safer way to grow their money.  And nothing signals stability and security like savings bonds. Backed by the full faith of the U.S. government, savings bonds offer an incredibly safe way to save and build money over time. 

Because savings bonds are essentially a loan to the government, bond purchases lead to an increase in overall national debt, but ultimately allow the government to spend and stimulate the economy. An increase in bond buying can be particularly beneficial for the government in times of a financial crisis.

A bond can also help you combat inflation: The Series I bond is attracting investor interest due to its high interest rate, Collin Martin, director of fixed income at the Schwab Center for Financial Research, recently told NextAdvisor. This makes for a decent counterweight to the rise in inflation, and it’s higher than the average annual government bond return of 5%-6%, according to Morningstar Direct.

In response to the growing $1 trillion budget deficit, the U.S. Treasury Department has started issuing a 20-year note for the first time in three decades and boosted the three, 10, and 30-year bond auctions to record amounts. So if you’re wondering whether a savings bond is right for you, here’s how they work.

Savings Bonds Explained

When you purchase a U.S. savings bond, you’re essentially becoming a creditor for the United States government. 

Think of it like taking out a loan. When you borrow money, you’re given an interest rate that will accrue on the balance until you finish paying off the loan. The longer you take to pay it back, the more you’ll pay in interest. Savings bonds work similarly; the difference is you’re the lender and the government is the borrower, and you can ask the government to pay you back at any time.

Since U.S. savings bonds are backed by the U.S. Treasury, they’re often considered one of the lowest-risk investments in the world, meaning you will never lose any of your principal investment. But this low risk also means they provide a low return on interest.

How to Buy a Savings Bond  

While U.S. savings bonds used to be issued on little pieces of paper, those days have come to an end. Electronic savings bonds can now be purchased online from TreasuryDirect, the U.S. Treasury’s electronic savings portfolio platform. If you’re attached to paper bonds, Series I bonds can still be purchased in paper form using your IRS tax refund when you file your annual tax return.

Savings bonds also have their tax advantages. You may have to pay federal income taxes on your savings bond, but not state or local income taxes. 

Purchasing a savings bond is fairly straightforward. When you buy a savings bond, you’ll choose an amount between $25 and $10,000 and decide whether you want to buy a Series EE or Series I bond. (Series I paper bonds are limited to $5,000.) 

You will pay half the price of the face value of the bond. For example, you’ll pay $50 for a $100 bond. Once you have the bond, you choose how long to hold onto it for — anywhere between one and 30 years. To get the full return of double your initial investment (plus interest), you’ll need to wait the full term to the bond’s maturity. While you can cash in a bond earlier, your return will be based on a maturation schedule that rises over the course of the bond’s term.

The Treasury promises Series EE savings bonds will reach face value in 20 years, whereas the Series I savings bond has no guarantee of value in maturity. Keep in mind both reach full maximum value at 30 years. 

The interest that compounds over time with a savings bond depends on its series. The government adjusts rates on Series EE and Series I bonds in May and November each year. For example, a Series EE bond has a fixed interest rate of 0.1% and a Series I bond has a composite rate of 9.62%, which will adjust for inflation every six months. Both rates are current until they go through their next adjustment in October 2022.

Types of U.S. Savings Bonds 

There are a few different types of savings bonds offered by the U.S. government. These bonds differ in the terms they come with, interest rates, and penalties. Here’s more about each bond type: 

Series E 

Series E bonds were first announced in 1941, as the U.S. entered World War II. They were replaced in 1980 by Series EE bonds, and are no longer available today. 

If you own an old Series E bond, you can still cash it in. Today, these bonds are worth their face value, plus any interest that accrued over the lifetime of the bond. You can also check the value of paper bonds on the Treasury’s website. Since Series E bonds are paper savings bonds, you’ll need to take it to the bank to cash.

Series EE 

Series EE bonds are today issued online by the U.S. Treasury. If you purchased a Series EE bond between May 1997 and April 2005, it earned a fixed interest rate, but any Series EE bonds purchased after May 2005 now come at a fixed rate. Interest is earned monthly over a 30-year period or until you cash the bond (whichever comes first). Series EE bonds issued between now and Oct. 2022 earn 0.10% interest. 

Series EE bonds are guaranteed to double in value if you keep them for 20 years. You must keep the bond for at least one year, but it continues to build interest for 30 years. You’ll face a penalty if you withdraw before five years. 

Series I 

Series I bonds today offer strong protection against inflation. The interest rate you’ll earn is based on the fixed interest rate when you buy the bond, and a variable rate that can change semiannually. Series I bonds currently earn interest at a rate of 9.62%.

You can get an electronic savings bond for minimum $25 or a paper savings bond for $50. Like Series EE bonds, you must hold the bond for 12 months, but interest accrues for up to 30 years. You can withdraw without facing a penalty after five years.  

How to Calculate the Value of Savings Bonds

Savings bonds are considered one of the safest investments you can buy.  The basic theory is that the value of a savings bond increases over time, but it’s easy to lose track of its worth over a long period of time. 

Luckily, TreasuryDirect’s savings bond calculator makes it simple to find the value of a purchased savings bond. To calculate the value of your savings bond, you’ll need to know the bond series, face value, serial number, and issue date. 

For example, if you purchased a $50 Series EE bond in May 2000, you would have paid $25 for it. The government promised to pay back its face value with interest at maturity, bringing its value to $53.08 by May 2020. A $50 bond purchased 30 years ago for $25 would be $103.68 today.  

Here are some more examples based on the Treasury’s calculator. These values are estimated based on past interest rates. Future interest rates will vary. 

Face ValuePurchase Amount20-Year Value (Purchased May, 2000)30-Year Value (Purchased May, 1990)
$50 Bond$25$53.08$103.68
$100 Bond$50$106.16$313.52
$500 Bond$250$530.80$1,036.80
$1,000 Bond $500$1,061.60$2,073.60

Pro Tip

The longer you hold a savings bond—up until its point of  maturity—the more it’s worth when you cash it in.

How to Cash in Your Savings Bond

Cashing in a Series EE or Series I savings bond is relatively easy. When it’s time to exchange your savings bond for cash, all you need to do is log into your account on TreasuryDirect and follow the instructions to redeem your bond. The cash value will be credited to your bank account within two business days. You’ll also get your bond’s interest income when cashing in your savings bond.

Bear in mind, all newly-issued savings bonds are electronic, and paper savings bonds can be converted to electronic bonds. If you have a paper savings bond, you’ll have to take it to a bank along with a photo ID to exchange it for cash. 

Before you cash in your savings bonds, it’s always good to check what they’re worth. Most savings bonds stop earning interest after 30 years, but you can redeem your savings bond before that period. You do have to wait at least a year after purchasing a savings bond to cash it in. The only exception to this rule is if you’re affected by a natural disaster. 

However, it’s usually wise to wait at least five years, or you’ll lose the last three months of interest when cashing in. It’s important to take the interest rate on your bond and your financial needs into account, but it’s generally better to wait until your savings bond has fully matured. 

How to Get the Most Out of Savings Bonds

To maximize your return with a savings bond, and there’s a few key things to consider. 

Because savings bonds traditionally have low returns, Yusuf Abugideiri, partner and senior financial planner at Yeske Buie, a financial advising firm with locations in San Francisco and Washington, D.C., recommends holding onto a savings bond until maturity to get the full return. This is especially the case for Series EE bonds since the Treasury promises to double any investment once they’ve reached 20 years of maturity. 

“You’ll get more out of a savings bond if you’re receiving interest over the full term, rather than cashing it out before maturity,” Abugideiri said. “Once you get past five years, you won’t have to pay any penalties, but you haven’t received all of the interest you could earn.” 

So, if you buy Series EE bonds, it’s best to plan to hold onto them for the full 20-year period if you can. 

And if you buy a Series I bond, you need to keep it for at least a year. If you cash out before five years, you forfeit three months of interest.

If you do decide to redeem your savings bond early, Abugideiri says there’s the option to take that money and invest it in other ways to earn more down the line. “If you cash out with no penalty, take the interest you got up to that point, and put that money to work in a different way, then that might be a way to further increase your returns,” Abugideiri said.

Savings Bonds vs. Savings Accounts 

A savings bond and a high yield savings account can both make good additions to your financial portfolio and offer more security than other investment vehicles. But savings bonds are typically better for longer-term savings, while savings accounts are more accessible. 

Start by thinking about how long you plan to invest the money. Savings bonds typically charge a penalty if you withdraw money before the five-year mark, meaning you should only buy them with money you know you won’t need for several years. Savings accounts, however, are very easy to access and offer more flexibility to withdraw and deposit money whenever you want. That makes savings accounts a better choice for short-term savings or your emergency fund.

Next, check the interest rate of the bond or account before investing. If you don’t plan to touch the money for several years, a Series I bond that’s designed to keep up with inflation could be a better way to earn. Savings account rates also change with the economy and can earn more or less depending on the federal funds rate set by the Federal Reserve. 

If you need quick and easy access to emergency funds, it’s best to put some of your money in a savings account. And for long-term investments, buying a savings bond at the right time can help you get the best rate.

It’s also important to remember that both of these safer options for your money are unlikely to result in the same potential return as more risky investments in index or mutual funds. Experts recommend diversifying your investment portfolio with a range of account types for the best mix of security and return. 

How to Gift a Savings Bond

While they won’t come with a huge payoff, savings bonds are still a financially prudent gift. Here’s a step-by-step guide on how to buy and give an electronic savings bond.

  1. Go to www.treasurydirect.gov, and log into your TreasuryDirect account or open an account in your name.
  2. Click on BuyDirect. On the purchase page, either select an existing registration from the drop-down list or create a new registration for the recipient by clicking “Add New Registration.”
  3. Have the recipient’s name and Social Security number on hand to register. Be sure to click the box, “This is a Gift.”
  4. Buy the type of savings bond you wish (Series EE or Series I), in a specific amount ($25-$10,000).
  5. Deliver the savings bond gift to the recipient’s TreasuryDirect account.
  6. Print out a gift certificate to give to the recipient.

Gift savings bonds usually take at least one business day to be issued in a TreasuryDirect account. Once issued, you can go back into your account and deliver it to the recipient. To receive the gift, the recipient must have his or her own TreasuryDirect account. 

The Bottom Line

If you’re thinking about investing in savings bonds, it’s important to know how they work and the impact they can have on your investment strategy. You are loaning your money to the government for a long time, and the government promises to pay you back with interest later. 

“The overall economy is the real concern,” said Troy Harmon, CFA, and chief investment officer at Henssler Financial, a Georgia-based financial advising firm. “I think the numbers can confirm we are in a recession currently.” During tough financial times, Harmon says savings bonds are a good way to diversify your portfolio and manage your risk. The returns are not as lucrative as stocks could be, but they are guaranteed. 

Lisa Bernardi contributed to this article.

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