financial literacy

How Do Savings Bonds Work?

Read this EarlyBird guide to find out what savings bonds are and whether they're a good investment.

Last updated:

June 12, 2022

EarlyBird helps parents, family, and friends collectively invest in a child’s financial future. Learn more.

What You'll Learn

When the stock market is doing well, investors are excited to take advantage of that growth. But during times of market volatility, people naturally start to shy away from stocks. And when that happens, they’re often looking for a lower-risk investment to put their money in.

That’s where savings bonds come in. Savings bonds have been around for more than 87 years, so they certainly aren’t new. But you may have seen them in the news more often lately.

Savings bonds come with plenty of benefits, including the fact that they’re entirely risk-free since the federal government issues them. They also make a great gift, thanks to their long time horizon and dependability — but if you want to maximize your returns, there are some great alternatives out there, too.

Are you wondering whether investing in savings bonds is right for you? In this guide, we’ll talk about how savings bonds work, the different types of savings bonds, how to invest in savings bonds, and whether they’re right for you.

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What Is a Savings Bond?

A savings bond is a low-risk investment class that you can use to generate a positive return over a relatively long amount of time.

Bonds can be issued by either companies or governments to raise money from a number of investors.

By selling bonds to investors, those companies or government bodies can then use the money now towards boosting operations and promoting growth. But the bond seller will be required to repay that money to the investor at a fixed point in the future — with added interest for the privilege of getting to borrow capital.

Screenshot of Series EE US bond
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As a result, you can essentially think of a savings bond as a loan.

Because the government automatically honors all of these debt agreements, federal government savings bonds are considered to be an incredibly safe investment option. In addition to a guarantee of repayment, the value of a savings bond never declines. This protects your investment from inflation.

Yet while the stability of a bond’s investment value is considered an advantage to some, it can also be a disadvantage.

Translation: bonds don’t increase in value. They simply mature over a period of time to reach the face value price you’ve paid (plus marginal interest). That means you aren’t going to create a huge nest egg for the future by purchasing bonds alone.

Suppose you’ve got a longer investment horizon and are willing to take on slightly more risk. In that case, it’s going to make more sense to spread your investment portfolio to include more lucrative assets like stock shares, mutual fund shares, or exchange-traded fund (ETF) shares. But we’ll get to investment alternatives and the vehicles that let you hold those asset classes in just a minute.

For now, let’s walk through how bonds work and how you can purchase them.

How Do Savings Bonds Work?

We’ve already mentioned that a savings bond essentially functions as a loan to the government. But there’s a bit more to it than that.

When you decide to buy a US Treasury bond, you’re giving the government a cash advance to fund various projects. You then earn interest in exchange for letting the government use that money — which is how your investment grows (albeit a small amount) over time.

There are two types of government savings bonds you’re going to be likely to encounter: Series I Bonds and EE Bonds. You can currently purchase these bonds in electronic form in a number of amounts ranging from $25 all the way to $10,000. They also used to be available in paper form ranging in amounts from $50 to $5,000 per year.

Government bonds reach their face value after a fixed number of years. This means that you’ll recoup your investment with interest after you’ve held that bond for the required number of years.

If you decide to sell a bond before it reaches maturity, you won’t receive the full amount. Instead, you’ll only get accumulated interest due on the bond up to the point that you sell it. You’ll also lose any rights to interest that would’ve accrued between the point of sale and its maturity date.

Illustration of woman drawing chart

Bond maturity dates vary. But it can take up to 30 years for some US Treasury bonds to reach full maturity. You’re allowed to redeem a savings bond at any point 12 months after you’ve purchased that bond.

Electronic bonds can be redeemed on the TreasuryDirect.gov website — and the sale amount will be redeemed directly into your checking or savings account. Older paper savings bonds you might already have can be redeemed at most local banks.

Alternatively, you can redeem an old paper bond by sending it in the post to Treasury Retail Securities Services. After your bond has been processed, the current value will then be deposited directly into your bank account.

What Are the Different Types of Savings Bonds?

There are two types of US Treasury bonds: Series I Bonds and Series EE Bonds.

Series I bonds use a composite interest rate. That rate includes both fixed interest as well as a fluctuating interest rate which is based on market inflation. That being said, it’s important to note that this composite rate only applies for a period of six months. After each six-month period, the rate changes again.

At the moment, the composite rate on Series I bonds is 9.62%. That rate will last until October 2022, and then it will change in line with market conditions.

As we’ve already touched upon, you can cash your Series I bond within one year of buying it. But if you sell your Series I bond within five years of buying it; you’re going to miss out on the last three months’ worth of interest that investment would have earned. A Series I bond matures when it reaches 30 years.

Screenshot of Series I US bond
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Next, you’ve got Series EE bonds.

Unlike Series I bonds, EE bonds earn you a fixed interest rate only. The US Department of the Treasury decides the fixed rate for new EE bonds twice each year: on May 1 and November 1. Currently, the fixed interest rate on new EE bonds is 0.10%. Again, this sort of interest probably isn’t going to put a huge dent in your kid’s college fees — but it does provide steady and predictable growth.

After buying a Series EE bond, its fixed interest rate won't change for the first 20 years of that bond’s life. But during the last 10 years before your bond matures, your fixed rate may go up.

Which is better: EE or I bonds?

The answer to this question depends on what you’re looking for in an investment. But generally speaking, you can expect to get a better return with a Series EE savings bond.

That’s because an EE bond has a fixed interest rate of return. As a result, the Series EE bond is designed to double its face value by the time it reaches its 20-year maturity. By contrast, Series I savings bonds aren’t guaranteed to reach the full advertised face value at the point of maturity. That’s because Series I bonds have a compound interest rate, which means they can go up or down.

Translation: EE bonds are normally considered a safer investment option if you’re trying to make sure you’ll recoup your full investment plus interest.

How To Invest in Savings Bonds

If you’d like to invest in a US savings bond, the quickest and easiest way to buy one is online.

To invest in a digital bond, all you’ve got to do is go to TreasuryDirect.gov. If you don’t yet have an account with TreasuryDirect, you’ll need to set one up. It’s a pretty simple process, but you’ll need to provide a number of personal details to get your account up and running.

Screenshot of TreasuryDirect.gov home page
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If you’ve already got an account, simply log in.

Next, click on “BuyDirect.” You’ll then be able to choose between continuing with an existing bond registration or creating a new registration. As part of that process, you must then indicate the type of bond you’d like to buy, as well as the amount you’d like to invest in.

If you’re purchasing the savings bond as a gift for somebody else, that individual will also need to have an active TreasuryDirect account. You’ll need to enter that individual’s name, Social Security Number (SSN), and their TreasuryDirect account number as part of the buying process. If you’re just buying the bond for yourself, it’ll get deposited directly into your account.

Do You Get Taxed on Savings Bonds?

Before investing in a savings bond, it’s important that you understand the tax implications of that investment.

A US Treasury bond is exempt from both state taxes and local taxes. But savings bonds aren’t exempt from US federal taxes. That means the owner of a bond has got to report any interest they earn from a savings bond on their federal income tax return.

That being said, there is one exception to this rule. If you cash in a savings bond in the same year that you pay for qualified higher education expenses, you’ll sometimes be exempt from paying federal taxes on your savings bonds.

But generally speaking, you should expect to pay taxes on interest accumulated in the same way you’d pay tax on any other sources of unearned income.

How To Cash in a Savings Bond

The easiest way to redeem (or “cash in”) a savings bond is to do it online.

All you need to do is log into your TreasuryDirect.gov account. You’ll then be able to access detailed instructions that’ll tell you how to redeem your bond.

It’s important to note you can now only buy digital bonds online. If you have older paper savings bonds, you’ll be able to cash in a bond at most local bank branches. Upon receipt, they’ll then be able to offer you a cash amount or deposit it directly into your account at the point of receipt.

Illustration of father with arm around son standing next to money

Again, a federal savings bond can be cashed in 12 months after you’ve bought it. But if you sell a bond within five years of buying one, you’ll end up losing the last three months’ worth of interest the bond has accumulated.

Are Savings Bonds a Good Investment?

A savings bond can be a good investment, depending on what you’re looking for in an asset class.

A savings bond is essentially a risk-free investment, and it can help you to moderate the risk of a mixed portfolio by offering a low-risk, low-return source of income.

People also like savings bonds because you don’t have to pay state tax or local taxes on the earnings your bonds generate. Finally, kids under 18 are able to own savings bonds. This isn’t the case with most investments, which makes it a good asset to gift children for the future.

But if you’re looking for a more lucrative way to invest for children, you may want to consider a UGMA custodial account instead.

With a custodial account, you can invest in a range of asset classes, including stocks, bonds, mutual funds, ETFs, and more for a child. You then serve as the manager (or “custodian”) of the investments in that UGMA until your child beneficiary reaches the age of majority. In most states, that’s either 18 or 21 years old.

A UGMA account comes with plenty of benefits — but one reason a lot of parents prefer setting up a custodial account for a child over simply purchasing bonds is that it enables them to create a mixed portfolio that can generate higher returns over time.

Mobile view of portfolio selection on Earlybird app
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For example, suppose you set up a UGMA account with EarlyBird. In that case, you can choose from five different ETF portfolios that are all built around a number of factors, including your risk tolerance, investment horizon, your long-term financial goals, and more.

You’re then able to invest cash into those portfolios over a number of years — generating compound interest and building a nest egg for the future that will likely trump the potential returns of a savings bond.

Conclusion

Whether you’re buying savings bonds for yourself or gifting them to someone else in your life, these government securities offer a unique opportunity to earn a risk-free return while avoiding some of the volatility of the stock market.

Just remember that you certainly aren’t going to get rich from savings bonds. Portfolio diversification is key for long-term investing, and savings bonds can help add exactly that to your portfolio.

But if you want to supplement the low-risk, low-return nature of savings bonds with something that will make your money work harder, EarlyBird can help. Download EarlyBird today to open a custodial account and start investing in the children you love.

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This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.

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EarlyBird Team

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INVEST EARLY, GROW TOGETHER
Download EarlyBird today and start investing in your child’s tomorrow.
INVEST EARLY, GROW TOGETHER
Download EarlyBird today and start investing in your child’s tomorrow.
INVEST EARLY, GROW TOGETHER
Download EarlyBird today and start investing in your child’s tomorrow.