A Traditional Savings Vehicle Which Still Makes Sense
U.S. savings bonds are savings certificates issued by the U.S. Treasury. They may seem a little old-fashioned, but these bonds have some interesting features and now can be purchased in electronic form as well as traditional paper bonds. Savings bonds often pay an attractive rate of interest compared to savings accounts or CDs and the interest earned has tax advantages.
Savings bonds currently are issued in two types: Series EE bonds earn a fixed rate of interest and series I savings bonds earn an inflation adjusted rate. Patriot savings bonds are series EE bonds with the term Patriot Bond printed on the bond certificates.
Both types of savings bonds have many of the same features. Savings bonds are non-transferable. A bond is registered to a specific owner or a pair of co-owners and only a listed owner can redeem a bond. If savings bonds are lost or stolen, the owner can apply to the Treasury for replacement bonds.
Savings bonds accrue interest every month and the interest is compounded every six months. A savings bond will continue to earn interest for up to 30 years if it is not redeemed. A new savings bond cannot be cashed in the first 12 months after purchase. If a bond is cashed within the first five years, a penalty will be charged equal to the most recent three months of interest earnings.
Paper savings bonds can be purchased at most banks. Many employers offer payroll deduction plans to buy savings bonds, usually in paper form. The electronic form of each bond type can be purchased by opening an account on the TreasuryDirect.gov website. Paper savings bonds can be redeemed at a bank or mailed to the Treasury for redemption by government check. To redeem by mail, a bank officer must first certify the signature and address on the bond to ensure the registered owner is requesting redemption. When electronic savings bonds are redeemed, funds are processed into the bank account which must be linked to every Treasury Direct account.
Keep in mind that the interest earned on savings bonds is exempt from state income tax. As bonds earn interest, the interest grows tax deferred and the income is only recognized for tax purposes when a bond is redeemed.
Series EE Bonds
Series EE bonds are the current version of the traditional U.S. savings bond. Paper series EE bonds are purchased for one-half the denomination value and earn interest to grow towards the value printed on the bond. The paper bond denominations are $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000. Electronic series EE bonds can be purchased in any amount from $25 to $5,000. The annual purchase limit is $5,000 of paper bonds and $5,000 of electronic EE bonds in any one year.
The Treasury sets the interest rate for new series EE bonds twice a year, on May 1 and November 1. Once an EE bond is purchased, it will earn the issue rate for the entire life of the bond. As noted above, interest accrues each month and the Treasury tracks savings bond values by the issue month. The current interest rate for series EE bonds issued through October 31, 2011 is 1.10 percent.
Series EE bonds have a guaranteed future value. For paper savings bonds, the value will reach the denomination amount no later than 20 years after the issue date. This means they double in value from the original purchase price and electronic EE bonds will double in the same time frame. If a savings bond has not reach the guarantee value by 20 years, the Treasury will make a one-time interest credit to bring the bond up to the correct value. It takes an interest rate of approximately 3.5 percent to get a double in 20 years, so savings bond buyers at the current rates will see a significant value boost if they hold the bonds long term. A bond will continue to earn interest at the issue rate for another 10 years after the guaranteed value date.
Series I Bonds
The Treasury issues series I bonds in both paper and electronic forms. Paper bonds are purchased for the denomination value and the available denominations are $50, $75, $100, $200, $500, $1,000 and $5,000. Electronic series I bonds can be purchased in any amount from $25 to $5,000. The annual purchase limit is again $5,000 of paper and $5,000 for electronic series I bonds.
Series I bonds have a two tier interest rate system. The bonds are issued with a fixed rate for the life of a bond in the same manner as with series EE bonds. In addition, the Treasury declares an interest rate factor every six months, which will increase or decrease the rate series I bonds are earning. The fixed rate for new bonds and the inflation factor for all series I bonds are declared each May 1 and November 1. The inflation rate factor is compiled from the Consumer Price Index – CPI.
The current rate for a series I bond is calculated by adding the fixed rate plus two times the semi-annual inflation rate. Currently, new series I bonds have a fixed rate of zero percent and the inflation factor in effect through October 31 is 2.6 percent. An I bond purchased now will earn interest at an annual rate of 4.6 percent until the end of October. If you had purchased an I bond in 2001 when the fixed rates on new bonds was three percent, your bond would be earning 7.6 percent for the current six month period.
The inflation rate factor can go negative if there is deflation instead of inflation. It is possible for the earnings on a series I bond to go to zero if the inflation factor is negative more than the fixed rate of a bond. In the 13 years I bonds have been available, the inflation factor was negative for one semi-annual period.
Regardless of the type of bond one may choose to purchase or redeem, as an investment vehicle, they are growing in acceptance and popularity. In uncertain economic times, they are proving to be a reliable tool for financial security.
Image: TreasuryDirect.gov, Public Domain