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How Do Savings Bonds Work?

Learn what U.S. savings bonds are, why they’re considered a safe investment, and the unique qualities that separate savings bonds from other long-term savings options. 

By Tony Azzara | American Express Credit Intel Freelance Contributor

6 Min Read | August 13, 2020 in Money

 

At-A-Glance

Saving bonds are extremely low-risk investments because they’re backed by the U.S. government.

There are two types of savings bonds – Series EE and Series I – and the interest rates for each work in different ways. Understanding how they work can help you decide which bond, if any, is right for you.

Depending on the savings bond you choose, you could double your investment – as long as you hold it for at least 20 years.

If you’re like me, what you know about U.S. savings bonds is that they’re those weird paper certificates your grandparents used to give you on your birthday – if you’ve even heard of them. But here’s a surprise: Because of a quirk in how certain savings bonds work, they could earn you slightly more than 3.5% a year in interest, if you hold them for the long term. In a world where bank savings accounts offer 0.1% or so, and even high-yield savings accounts are at around 1–2%, that’s a sweet deal. 

 

Let’s make this crystal clear:

  • A $500 Series EE savings bond is worth $1,000, if you hold it for 20 years. A $10,000 bond is worth $20,000 after 20 years. That works out to 3.53% per year.
  • The same $10,000 in a savings account earning 2%, compounded monthly, is worth only $14,913 after 20 years.1  
  • You may not even pay tax on the interest if you redeem the bond for higher education expenses.2
  • But there’s a catch – they’re worth a lot less if you cash them in before 20 years. 

This article outlines information to help you decide whether savings bonds are a good investment for you, including:

  • The two kinds of savings bonds you can buy today.
  • Their interest rates.
  • Where you can buy them.
  • How you cash them in. 

The catch on the 3.5% deal is time – if you cash in the $10,000 Series EE bond a day before its 20th birthday, it’ll be worth only a little more than $10,200. To understand how both things can be true, you need to know how savings bond interest rates work.

 

What Are the Two Types of Savings Bonds & Their Interest Rates?

There are two types of U.S. savings bonds available today, Series EE and Series I. Here’s how their interest rates work:

  • Series EE: For Series EE bonds issued from November 2019 to April 2020, you’ll earn an interest rate of 0.1%. If that seems low, it is. It’s the rate that works out to only $10,200 if you cash in a day short of 20 years, as mentioned above. But the U.S. Treasury “guarantees” you will double your money if you hold a Series EE bond for 20 years.3 So, Treasury makes a one-time adjustment on the 20th anniversary of the day you bought the bond, to value it at double the original face value.
  • Series I: These bonds earn a variable interest rate tied to inflation, and there is no doubling promise. Instead, Series I bond interest rates include two components: a fixed rate for the life of the bond, plus a variable component that rises and falls depending on the inflation rate, and is updated twice a year.4

For example, for Series I bonds issued from November 2019 through April 2020, the combined interest rate is 2.22%. The two components in this case are a fixed rate of 0.20% and an inflation rate of 2.02%.5

 

As a result, investors can use Series I bonds to protect against rising inflation. For example, if you believe inflation is going to rise from its current low level to the mid-teens, as it did in the 1980s6, Series I bonds would be a far better savings choice then Series EE, because the Series I interest rate automatically rises with inflation. But if you think inflation will stay low, and interest rates won’t change much in the next 20 years – and you can afford to park some cash for that long – Series EE bonds might be your choice. 

 

Both bonds stop earning interest after 30 years.

 

Where Can You Buy Savings Bonds?

You can buy savings bonds only directly through the U.S. Treasury, almost exclusively online through TreasuryDirect.gov. The only exception is that you can buy a paper Series I bond with your tax refund, up to $5,000, by filing IRS Form 8888 with your tax return.7 Otherwise, you have to set up an online account at TreasuryDirect, tie it to your bank account, and buy Series EE or Series I bonds in electronic form.

 

Who Can Buy Savings Bonds?

Anyone can buy U.S. savings bonds, as long as you’re 18 or older, have a Social Security number, and are a U.S. citizen, U.S. resident, or an employee of the U.S. government. You can also give them as a gift, as long as you know the recipient’s Social Security number, but your recipient must also have an account at TreasuryDirect.

 

How Much Can You Buy in Savings Bonds?

You can purchase either bond in any amount, to the penny, up to $10,000, which is the maximum you can buy each year. For example, you could buy a bond worth $123.45, or $9,902.37. The maximum amount you can purchase for each bond, each year, is $10,000. That’s $20,000 total. But, if you’re getting a tax refund of at least $5,000, you can also get a Series I paper bond, boosting your yearly maximum to $25,000. 

 

How Do You Cash in Savings Bonds?

Once they’re at least a year old, you can cash in your electronic bonds any time by logging into your TreasuryDirect account, checking their current value on the “Current Holdings” tab, and following the on-site redemption instructions.8 Funds can be transferred to your bank account in two business days. If you have paper bonds – including EE, I, and older Series E bonds which were discontinued in 1980 and no longer accrue interest – you can cash them in at any bank branch. Series HH paper bonds, which were discontinued in 2004, will continue to accrue interest until 2024, and can only be cashed in by mailing them to the U.S. Treasury.9

 

 

So Then, Are Savings Bonds a Good Investment?

Only you can decide whether savings bonds are a good investment. Can you hold a bond for 20 years? Can you earn more than 3.5% by investing in other ways? Would it be worth the risk? That last consideration is key, since savings bonds are backed by “the full faith and credit” of the U.S. government – a phrase that promises an unconditional guarantee. That’s about as low-risk an investment as you’ll ever find.

 

 

 

The Takeaway

In general, U.S. savings bonds are a low-risk way to save for the future – and they generate equally low returns. But what makes them more interesting for long-term savings consideration is that Series I bonds are linked to inflation, while Series EE bonds are guaranteed to double in value when they turn 20 years old – which translates into a 3.5% annual return.

Tony Azzara

Tony Azzara is a business technology writer and researcher based in Queens, NY, whose work focuses primarily on financial services technology.

 

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

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