What Is a Savings Bond? How Do Savings Bonds Work?

A U.S. Savings Bond is an investment in our federal government that grows your money. When you buy a U.S. Savings Bond, you’re lending money to the government with the express guarantee that you’ll get it back, plus a little interest. You won’t make much in interest on a savings bond, but because they are backed by the full force of the federal government, the investment is considered extremely low-risk. And, in some cases there are tax advantages.

Let’s take a closer look at the ins and outs of these investments. We’ll cover:

•  What a savings bond is and how it works

•  The different types of savings bonds

•  How to buy and redeem savings bonds

•  The pros and cons of buying savings bonds

Let’s get started.

Savings Bond Definition

First, let’s answer the basic question, “What is a savings bond?” Basically, it is a loan issued by the U.S. Treasury and made to the U.S. government. Purchase a savings bond, and you are loaning the money you pay to the government. At the end of the bond’s 30-year term, you receive your initial investment plus the compounded interest; you may withdraw funds before then, as long as the bond has been held for at least five years.

How Do Savings Bonds Work?

Savings bonds are issued by the U.S. Treasury. You can buy one for yourself, or for someone else, even if that person is under age 18. (That’s why, when you clean out your closets, you may find a U.S. Savings Bond that was a birthday present from Grandma a long time ago.) You buy a savings bond for face value, or the principal and the bond will then pay interest over a specific period of time. Basically, these savings bonds function the same way that other types of bonds work.

You can buy savings bonds electronically from the U.S. Treasury’s website, TreasuryDirect.gov . For the most part, it’s not possible to buy paper bonds anymore but should you run across one, you can still redeem them. (See below). Unlike many other types of bonds (say, some high-yield bonds), you can’t sell savings bonds or hold them in brokerage accounts.

Different Types of Savings Bonds

There are two types of U.S. Savings Bonds available for purchase — Series EE and Series I savings bonds. Let’s take a look at the differences between the two.

Series EE Bonds

Introduced in 1980, Series EE Bonds earn interest plus a guaranteed return of double their value when held for 20 years. These bonds continue to pay interest for 30 years. Bonds purchased between May 1997 and April 2005 may earn a variable interest rate. Series EE Bonds issued after May 2005 earn a fixed rate.

The current Series EE interest rate for bonds issued May 2021 through April 2022 will earn an annual fixed rate of 0.10%.

Series I Bonds

Series I Bonds pay a combination of two rates. The first is the original fixed interest rate. The second is an inflation-adjusted interest rate, which is calculated twice a year using the consumer price index for all urban consumers (CPI-U). This adjusted rate is designed to protect bond buyers from inflation eating into the value of the investment.

When you redeem a Series I Bond, you get back the face value plus the accumulated interest. You know the fixed rate when you buy the bond. But the inflation-adjusted rate will vary depending on the CPI-U during times of adjustment.

The current composite rate for Series I Savings Bonds is 7.12% for I bonds bought from November 2021 through April 2022.

Municipal Bonds

Municipal bonds are a somewhat different savings vehicle but are worth a quick overview here, if only as a point of comparison. They are issued by a state, municipality, or country to fund capital expenditures. By offering these bonds, projects like highway or school construction can be funded. Akin to loans that investors make locally to improve their area, these bonds (sometimes called “munis”) are exempt from federal and the majority of local taxes, making them perhaps more enticing to some investors. The market price of bonds will vary with the market, and they typically require a larger investment of, say, $5,000. Municipal bonds are available in different terms, ranging from relatively short (say, two to five years) to longer (the typical 30-year length).

How To Buy Bonds

You can buy Treasury Bonds directly through the United States Treasury Department online account system called TreasuryDirect, as noted above. This is a little bit different than the way you might buy other types of bonds. You can open an account at TreasuryDirect just as you would a checking or savings account at your local bank.

You can buy either an EE or I Savings Bond in an amount ranging from $25 to $10,000 in penny increments. So, if the spirit moves you, go ahead and buy a bond for $49.99. The flexible increments allow investors to dollar cost average and make other types of calculated purchases. That said, there are annual maximums on how much you may receive in savings bonds. The electronic bond maximum is $10,000 and paper is $5,000.

Speaking of paper, Series I Bonds are the only savings bonds still available to buy as paper. But that process is very specific. You may only buy paper Series I Savings Bonds with your federal tax refund. So that means you must first qualify for a tax refund before you can purchase paper I Bonds.

If you are due a refund and you want to buy I Bonds, be sure to file IRS Form 8888 when you file your federal tax return. On that form you’ll specify how much of your refund you want to use to buy paper Series I bonds, keeping in mind the minimum purchase amount for a paper bond is $50. The IRS will then process your return and send you the bond that you indicate you want to buy.

The Pros & Cons of Investing in Savings Bonds

Let’s take a look at the possible benefits and downsides of investing in savings bonds. This will help you decide if buying these bonds is the right path for you, or if you might prefer to otherwise invest your money or stash it in a high yield bank account.

The Pros of Investing in Savings Bonds

Low risk. U.S. Savings Bonds are one of the lowest risk investments you could ever make. You are guaranteed to get back the entire amount you invested, known as principal. You will also receive interest if you keep the bonds until maturity.

Tax advantages. Savings bond holders don’t pay state or local taxes on interest at any time. You don’t have to pay federal income tax on the interest until you cash in the bond.

Education exception. Eligible taxpayers may qualify for a tax break when they use U.S. Savings Bonds to pay for qualified education expenses.

No fees. Unlike just about every other type of security, you won’t pay a fee, markup or commission when you buy savings bonds. They’re sold at face value, directly from the Treasury, so what you pay for is what you get. If you buy a $50 bond, for example, you’ll pay $50.

Great gift. Unlike most securities, people under age 18 may hold U.S. Savings bonds in their own names. That’s what makes them a popular birthday and graduation gift.

Patriotic gesture. Buying a U.S. Savings Bond helps support the U.S. government. That’s something that was important and appealed to investors when these savings bonds were first introduced in 1935.

The Cons of Investing in Savings Bonds

Low return. The biggest disadvantage of savings bonds is their low rate of return. (Recently, rates were 0.10% for a new EE bond and about 3.54% for a new I bond.) A very low risk investment like this often pays low returns. You may find you can invest your money elsewhere for a higher return with only slightly higher risk.

Purchase limit. For U.S. Savings Bonds, there’s a purchase limit per year of $10,000 in bonds for each series (meaning you can invest a total of $20,000 per year), plus a $5,000 limit for paper I bonds. For some individuals, this might not align with their investing goals.

Tax liability. It’s likely you’ll have to pay federal income tax when you cash in your savings bond, unless you’ve used the proceeds for higher education payments.

Penalty for early withdrawal. If you cash in your savings bond before five years have elapsed, you will have to pay the previous three months of interest as a fee.

Here, we summarize the pros and cons of investing in savings bonds:

Pros of Savings Bonds	Cons of Savings Bonds
Low risk	Low returns
Education exception	Purchase limit
Tax advantages	Tax liability
No fees	Penalty for early withdrawal
Great gift
Patriotic gesture

When Do Savings Bonds Mature?

You may wonder how long it takes for a savings bond to mature. The EE and I savings bonds earn interest for 30 years, until they reach their maturity date.

How to Cash in Savings Bonds

Wondering how and when to redeem a savings bond? These bonds earn interest for 30 years, but you can withdraw penalty-free after five years.

If you cash in a U.S. Savings Bond before five years, you’ll pay a penalty that is the equivalent of the previous three months of interest. Keep in mind that for EE bonds, if you cash in before holding for 20 years, you lose the opportunity to receive the doubled value of the bond that accrues after 20 years.

If you have a paper bond, you can cash it in at your bank or credit union. Bring the bond and your ID.
For electronic bonds, log into your TreasuryDirect account, click on “confirm redemption,” and follow the instructions to deposit the amount to a linked checking or savings account. You will likely get the money within two business days.

If you inherited or found an old U.S. Savings Bond, you can redeem savings bonds through the Treasury Retail Securities Services. Make sure you have the type of bond, serial number, and the date it was issued. You’ll use FS Form 1522 , which has the mailing address on it.

The Takeaway

U.S. Savings Bonds are one of the safest ways to invest for the future and show your patriotism. These bonds can be especially great gifts for minors. But they can also add a risk-free guaranteed return to your portfolio. While the interest rates are typically low, for some investors, knowing that the money is being securely held for a couple of decades can really enhance their peace of mind.

Another way to help increase your peace of mind and financial wellbeing is banking with SoFi. With our Checking and Savings, you’ll earn a competitive APY when you sign up with direct deposit. Plus, you’ll avoid fees. So your money makes more money, and we don’t charge you for that privilege.

See how much better banking can be with SoFi.

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Photo credit: iStock/AlexSecret

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