U.S. Savings Bonds: Definition, How They Work, Types, and Taxes

What Are U.S. Savings Bonds?

A U.S. savings bond is a government bond offered to its citizens to help fund federal spending, and which provides savers with a guaranteed, although modest, return. These bonds are issued with zero coupon at a discount with an implied fixed rate of interest over a fixed period of time. For instance, Series EE savings bonds are sold at 50% of their face value, and mature to their full value after 20 years.

Understanding U.S. Savings Bonds

A U.S. savings bond is a common type of government bond, which is a bond issued by a governmental body to raise funds from the public to fund its capital projects and other operations necessary to manage the economy. When the government sells bonds, it is in effect taking a loan from the public, which it promises to pay back at some predetermined date in the future. As compensation for providing it with capital, the government makes interest payments to its bondholders. 

Many people find these bonds attractive because they are not subject to state or local income taxes. These bonds cannot easily be transferred and are non-negotiable.

History of the U.S. Savings Bond

In 1935, during the Great Depression, President Franklin D. Roosevelt signed legislation that allowed the U.S. Department of the Treasury to issue federally backed savings bonds, Series A. In 1941, the Series E bond was first issued to help finance World War II and were called Defensive Bonds. After the attack on Pearl Harbor, they were called War Savings Bonds, and the money invested in them went directly toward the war effort.

After the war ended, Americans were encouraged to purchase savings bonds, which provided a way for individuals and families to earn returns on their investments while enjoying the absolute guarantee of the United States government. 

Features of U.S. Savings Bonds

• Non-Marketable: The U.S. savings bond was designed to be non-marketable, meaning that an investor can only purchase the bond directly from the U.S. government and cannot sell it to any other investor. The bond, in effect, cannot be transferred, as it represents a contract between the investor and the U.S. government. This direct relationship ensures that the U.S. savings bond does not fluctuate in value. Therefore, an investor would receive their original investment if they redeemed the bond. Furthermore, any lost or damaged savings bond certificate can be reissued or replaced, since the bond is registered with the government.
• Purchase: An investor can buy the bonds in penny increments with a minimum investment value of $25 and a maximum value of $10,000. A bond investor cannot buy more than $10,000 face value of U.S. savings bonds in a calendar year. U.S. savings bonds can only be purchased and redeemed electronically through the TreasuryDirect website administered by the government. The investor must open a TreasuryDirect account and provide a Social Security Number (SSN), checking or savings account, and email address.
• Interest payment: U.S. savings bonds are zero-coupon bonds that do not pay interest until they are redeemed or until the maturity date. The interest compounds semi-annually and accrues every year for 30 years. After a bond has been held for 30 years, it will no longer generate interest payments to the investor. An investor who purchases the bond at the end of the month will still receive the interest accrued for the entire month. Any interest paid at redemption or maturity date is issued electronically to the bondholder’s designated bank account.
• Early redemption: The time it takes for a bond to mature varies, but it is often between 15 and 30 years. A bondholder must wait at least 12 months after the initial purchase before redeeming the savings bond, at which point they will receive the face value plus interest. Furthermore, investors who redeem the bonds within the first five years of purchase will forfeit the last three months’ interest as a penalty. However, redeeming a bond after holding it for five years does not incur any penalty.
• Tax consequences: The interest earned from savings bonds is exempt from state and local income taxes. However, federal taxes apply, but only in the year in which the bond matures, is redeemed, or after 30 years, when the bond stops earning interest. If the investor uses the proceeds from the bond redemption to pay tuition for higher education, they may be exempt from higher taxes.

Types of U.S. Savings Bonds

There are presently two types of U.S. savings bonds that can be purchased electronically are the Series EE and Series I bonds. We'll talk more about Series EE and Series I in the following sections.

• Series EE U.S. Savings Bond: The Series EE savings bond replaced the Series E bond in 1980. These bonds are sold at face value and are worth their full value upon redemption. These bonds offer a fixed rate of interest, which is paid at maturity or redemption.
• Series I U.S. Savings Bond: The Series I savings bond was introduced in 1998. Like the Series EE bond, the Series I is sold at face value. These bonds offer a rate of interest adjusted for inflation, making the interest rate somewhat variable. If inflation increases, the interest rate on the savings bond will be adjusted upward. During periods of deflation, the bonds are guaranteed never to drop below 0.00%.
• Series HH bonds are no longer available for purchase. The U.S. government discontinued these bonds as of Aug. 31, 2004. Bonds that didn't mature continued to receive interest payments. The Series HH bond were 20-year, non-marketable savings bond issued by the U.S. government.

Series EE U.S. Savings Bond

Series EE Bonds are a type of U.S. savings bond that offers a fixed interest rate for the life of the bond. These bonds are often referred to as "patriot bonds" and are widely known for their guaranteed return. The U.S. Treasury guarantees that an EE Bond will double in value after 20 years, regardless of the prevailing interest rates during that period. This makes them a reliable, low-risk investment option for individuals who are looking for a safe place to store their money with a guaranteed return.

The interest is compounded semiannually, and the bond continues to earn interest for up to 30 years. If you redeem the bond after 20 years, you’ll receive the guaranteed doubled amount, but you can keep the bond for an additional 10 years to earn more interest. EE Bonds are also exempt from state and local taxes, and federal taxes on the interest can be deferred until the bond is cashed in or matures.

The interest earned on these bonds is exempt from state and local taxes, and federal taxes can be deferred until the bond is redeemed or matures. Additionally, if the bonds are used to pay for qualified education expenses, the interest may be tax-free under certain conditions. The interest is compounded semiannually, meaning that the interest earned is added to the bond’s principal, and future interest is calculated on the new, higher amount several times a year.

Series I U.S. Savings Bond

Series I Bonds are designed to protect your investment from inflation. These bonds earn interest through a combination of a fixed rate, which is set at the time of purchase, and a variable inflation rate, which is adjusted twice a year based on changes in the Consumer Price Index. This means that the interest you earn on I Bonds can increase if inflation rises, helping to preserve the purchasing power of your investment.

I Bonds are particularly attractive in periods of high inflation because the variable rate can offer returns that outpace those of other fixed-income investments. Like EE Bonds, I Bonds are backed by the U.S. government, making them a safer investment. They also offer the same tax advantages, with interest being exempt from state and local taxes, and the option to defer federal taxes until redemption or maturity. Additionally, the interest earned on I Bonds can be tax-free if used for qualified education expenses under certain conditions.

Another important feature of I Bonds is their flexibility. The interest rate is adjusted every six months based on inflation, providing a hedge against rising prices. However, the total return can fluctuate depending on inflation rates, which can be either a benefit or a drawback depending on economic conditions. I Bonds also have a 30-year maturity period, but you must hold them for at least one year before redeeming them, and if you cash them in before five years, you’ll lose the last three months of interest.

U.S. Savings Bond vs. Corporate Bond

U.S. savings bonds and corporate bonds are both types of debt securities, but they differ significantly in terms of risk, return, and purpose. Corporate bonds are issued by private companies to raise capital for various purposes such as expanding operations, financing mergers, or paying off existing debt. Unlike U.S. savings bonds, corporate bonds carry a higher level of risk because their repayment depends on the financial health and performance of the issuing company (which could go bankrupt).

If the company faces financial difficulties or goes bankrupt, there is a risk that bondholders may not receive their full principal or interest payments. The level of risk varies depending on the company’s creditworthiness, which is reflected in its credit rating. Higher-rated corporate bonds, known as "investment-grade" bonds, are less risky but offer lower returns, while lower-rated "junk" bonds offer higher returns in exchange for greater risk. It's possible for an investor to buy a bond, then only receive a portion of their capital returned to them (i.e. incur a loss).

In terms of returns, corporate bonds generally offer higher yields compared to U.S. savings bonds. This higher return compensates investors for the increased risk associated with corporate bonds. Additionally, corporate bonds often have more complex terms and conditions, such as call provisions that allow the issuer to repay the bond before its maturity date.

Another difference lies in the taxation of these bonds. Interest earned on U.S. savings bonds is subject to federal income tax but is exempt from state and local taxes. Additionally, the interest may be tax-free if used for qualified education expenses. Corporate bonds, however, do not offer these tax benefits. The interest from corporate bonds is fully taxable at the federal, state, and local levels.

The Bottom Line

U.S. savings bonds are low-risk, government-backed securities that allow individuals to lend money to the U.S. government in exchange for interest over time. They are known for their safety, tax benefits, and suitability for long-term savings goals.