United States Savings Bonds
The United States Savings Bond, backed by the full faith and credit of the United States government, is the bond that most people own, and one which most people are familiar with. Anyone with a social security number, including minors, or an organization with a tax identification number, such as a corporation, can own savings bonds. Bonds can also be co-owned, and a beneficiary can be designated. If the bonds are lost, stolen, or damaged, the U.S. government will replace them.
You can buy the bonds without paying any commission or fee at virtually any bank or credit union, or you can buy them direct from the federal government at https://www.TreasuryDirect.gov, where you can calculate the bonds' worth at any time, and arrange to buy them regularly through a payroll deduction plan, or by deducting it directly from your checking or savings account.
Savings bonds, being nonmarketable securities, cannot be traded or marketed. Both principal and interest are paid to the owner of the bond. Savings bonds can be redeemed after owning them for 1 year according to a formula specified when the bond was issued; otherwise, an interest penalty may be assessed for earlier redemptions.
Savings bonds are accrual bonds (aka accrual-type savings securities, appreciation-type securities), which pay interest by adding to the principal of the bond, in the same way that interest is added to the principal of a savings account — hence, the name savings bonds. The interest is added to the bond's principal every 6 months from the issue date, so interest is compounded semiannually. Although savings bonds share more characteristics with a savings account than most bonds, the bond part of the name is derived from the fact that savings bonds originated as paper certificates that shared many of the characteristics of other paper bonds. Nowadays, all bonds are becoming electronic, where the information about them is stored as a record in an electronic database, much as savings and other bank accounts are stored. Hence, savings bonds not only pay interest like a savings account, but, in electronic form, they are also stored like a savings account, in that there is database record with the name of the bondholder and the amount of the principal and interest. The bondholder gets both principal and interest by redeeming the bonds.
Savings bonds pay interest for up to 30 years, which is added at the end of each month, so if you buy a bond on the last day of the month, you'll get a whole month's interest, but if you redeem the bond on the last day of the month, you'll forfeit a month's interest. There is no accrual of interest during the month.
Comparing Series EE and Series I Savings Bonds
There are 2 types of savings bonds available for sale: EE Bonds and I Bonds. Both come in electronic form, which are simply accounts at TreasuryDirect.gov that store the information associated with the bond. Only I bonds can also be purchased as paper bond certificates or by using your tax refund.
The main distinction between EE and I Savings Bonds is that EE Bonds issued after May 1, 2005 pay a fixed rate of interest, whereas I Bonds pay an interest rate partly fixed and partly variable, and is adjusted for inflation each May and November by the Treasury Department according to the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for the 6-month period that ends 2 months before the resetting of the interest rate. (Mnemonic: think I for inflation-adjusted.) So, the interest rate set in November is based on the 6-month period from March to September. Because of the inflation component, I bonds pay much more interest than EE bonds. However, there is a guarantee that the interest earned on EE bonds will at least equal the bond principal in 20 years, doubling your money; otherwise, the Treasury Department will make up the difference.
The general interest rate that applies to newly purchased I bonds is set on the 1st business day every May and November. The interest rate for individual bonds depends on when the bond is purchased. Thereafter, the bond will earn the same interest rate for 6 months, even if the general interest rate is changed. After the 6 months elapses, the interest earned in the previous 6 months will be added to the bond principal, then the bond, with the newly added interest, will start earning the new interest rate set for that 6-month period for another 6 months, and so on.
How the Interest Rate Applies to Bonds
- November: The Treasury Department sets the interest rate for I savings bonds at 5%.
- January: An I bond is purchased for $100. This bond will earn interest at an annualized 5% for the next 6 months.
- May: The Treasury Department sets the interest rate at 6%.
- July: The $2.50 earned by the I bond in the previous 6 months is added to the bond principal.
- = $100 + $100 × 0.05/2 = $102.50
- Even though the interest rate was set at 5%, it is divided by 2 because the semiannual rate of 2.5% applied during the 6-month term of the bond to which the rate applied.
- July: The bond starts earning aan annualized 6% interest rate on $102.50.
- November: the Treasury Department sets the interest rate at 4%.
- The I bond continues to earn interest at the rate of 6% until the end of December.
- January: The I bond starts earning interest at the new rate of 4% until the end of June on the new bond principle of $105.58 (= $102.50 + $102.50 × 0.06/2 = $102.50 + $3.08).
- This will continue until the bond is either redeemed or 30 years have elapsed.
- Thus, the interest earned by the bond is compounded semiannually.
When an I bond is purchased, the fixed interest rate never changes; only the inflation-adjusted interest rate changes. The combination of the fixed interest rate and the inflation-adjusted interest rate is called the composite rate or the earnings rate, calculated thus:
I-Bond Composite Rate = Fixed Rate + 2 × Semiannual Inflation Rate + Fixed Rate × Semiannual Inflation Rate
If the fixed rate = 0, as it often is, then:
I-Bond Composite Rate = 2 × Semiannual Inflation Rate
I bonds and EE bonds share the following characteristics:
- Bonds can be purchased through a personal TreasuryDirect account.
- Electronic bonds and paper I Savings Bonds are sold at face value; so, you pay, for instance, $100 for a $100 bond; paper EE Savings Bonds are sold at half of face value, so you pay, for instance, $50 for a $100 bond.
- Bonds must be held for at least 1 year.
- A penalty of the last 3-months interest is applied if the bond is redeemed before 5 years.
- Maximum purchase in 1 calendar year: $10,000 for each bond in electronic form and $5,000 for paper I bonds, so $15,000 of I bonds can be purchased in a calendar year. Paper EE Savings Bonds are no longer issued in paper format.
- Minimum purchase is $25 for electronic bonds and $50 for paper I-bonds, but bonds can be purchased for any amount above that, up to the limit.
- Denominations available for sale: $50, $75, $100, $200, $500, $1,000, $5,000.
- Interest is paid at fixed intervals — there is no accrual of interest between the payments.
I Bonds, but not EE Bonds, can be bought using your tax refund, but the purchase must be in multiples of $50, up to a maximum of $5000 for the year. Using all available methods of purchase, the total amount of I bonds that can be bought in a calendar year is $15,000. The bonds can be registered to you or your spouse or to another co-owner beneficiary by completing Form 8888, Allocation of Refund (Including Savings Bonds Purchases) with the U.S. Treasury. This limit also applies to gifts per recipient. So, if you have 3 children, you can buy up to $15,000 of I bonds for each child.
Savings Bond Tips
- Buy only I bonds, not EE bonds, because I bonds pay a much higher interest rate. For instance, in November 2021, I bonds were paying 7.12%, while EE bonds were paying 0.1%, a difference of 7.02%!
- Until April 2022, because of the higher inflation after the Covid-19 pandemic, I bonds are paying an initial 6-month rate of 7.12%! Probably the best guaranteed rate you can find anywhere without risking principal!
- The bond purchase limits apply to each calendar year, so you could buy $10,000 worth of bonds in December and another $10,000 worth of bonds the following January.
- Interest is compounded semiannually, every 6 months from the bond's issue date. Every 6 months, the interest earned in the previous 6 months is added to the bond’s principal, which, thereafter, earns additional interest.
- Buy savings bonds at the end of the month, but redeem them at the beginning of the month to earn a full 2 extra months of interest, since a full month of interest is earned by owning the bond for any portion of the month.
Taxation of Savings Bonds
Bond interest is reported on Form 1099-INT. The interest earned from savings bonds is not subject to state or local taxes but is subject to federal taxes in the year of redemption or maturity. So, for instance, the last issue of Series E bonds has matured in June 2010, so bondholders of that issue must report all interest on those bonds in 2010.
Although the taxation of bond income is normally deferred until either redemption or maturity, the bondholder can elect to report the interest annually. The bondholder can switch between annual reporting and deferment at any time. When switching to reporting annually, the bondholder must report all the interest that has accrued to the year when the switch was made. The election must be made by the due date of the return for the tax year. To switch back to deferred interest, a statement must be attached to the taxpayer's federal income tax return requesting the change.
If any bond interest has previously been reported, then the taxpayer should list the full amount of the bond interest on Schedule B of Form 1040. The total interest earned by the bond should be listed, then, on a separate line, and the amount of interest that was previously reported should be listed as "Previously Reported U. S. Savings Bond Interest".
Special rules apply to the co-owners of bonds. A taxpayer who paid entirely for the bond is taxed on all the interest when it is redeemed, even if it is redeemed by the co-owner. If the co-owners each contributed toward the purchase price of a bond, then they are taxed on the interest that is proportional to their contribution percentage of the purchase price.
Example: How Co-Ownership of a Savings Bond Affects the Tax Liability of the Co-Owners
- A father pays 75% of a savings bond and his daughter pays 25%.
- The daughter redeems the bond 20 years later.
- Therefore, the father must report 75% of the interest on his tax return and the daughter, 25%, even though the daughter received the full amount of the redemption.
Because savings bonds are nontransferable, a bondholder cannot simply give savings bonds as a gift. The bonds have to be surrendered and then reissued in the recipient's name. When the bonds are redeemed, then the interest is taxable to the bondholder in the year of redemption. However, bonds transferred to a grantor trust, which the taxpayer created, that are not immediately taxable, but the transfer must be effected by filing FS Form 1851, Request to Reissue United States Savings Bonds to a Personal Trust with the U.S. Treasury.
If a bondholder dies before redeeming a savings bond, then all the interest is payable to the beneficiary, so the beneficiary pays the tax when the bond is redeemed or matured. However, if the income is reported on the decedent's final tax return, then the beneficiary must pay tax only on the interest earned henceforth, which would be nil. Any estate tax paid on the bond interest is deductible by the beneficiary as a miscellaneous itemized deduction.
Tax Savings for Children
Taxes on bonds for children may be saved by putting the bonds in the child's name only and filing a tax return for the child, electing to report the interest annually, so that the child's tax rate is applied to the child's income. If the child's income stays less than the standard deduction for children with investment income (2021: = Greater of $1,100 or Earned Income + $300), then no return needs to be filed for the child. When the bond matures, then the child may receive the proceeds tax-free.
However, if the child receives significant income, then kiddie tax rules may apply. The accrued interest may be deferred until the bonds are redeemed, when the interest would be taxed at the child's rate if he is at least 19 years old, or 24 years old if he is a full-time student; if younger, then the kiddie tax will apply. If the election is made to report accrued interest annually, then it must be reported every year in which the child's income exceeds their standard deduction, until the bonds are redeemed, unless IRS Form 3115 is filed to change the accounting method, which is explained fully in Savings Bonds section of IRS Publication 550, Investment Income and Expenses.
Education Tax Exclusion
One exclusive benefit of savings bonds is the Education Tax Exclusion, which allows qualified taxpayers to redeem their bonds tax-free if the proceeds are used to pay for certain educational expenses at qualified institutions. More information: Education Savings Bonds Program
Investors can open a TreasuryDirect account at TreasuryDirect.gov, where money can be accumulated through payroll deductions or ACH transactions from other banking accounts. The money earns no interest, which is why it is called a Zero-Percent Certificate of Indebtedness (C of I), until it is used to purchase savings bonds or Treasuries. I can only imagine that why it is called C of I, since it is only an account with money in it, is because TreasuryDirect uses the same software to manage the accounts as it does to manage its bonds. However, any amount of money can be deposited, so that if an investor wants to automatically deduct less than what is necessary to buy bonds, then he can allow it to accumulate until he has enough. The TreasuryDirect platform provides account statements to the investor and other tools to manage the account from a computer.
Find more information about the payroll feature at TreasuryDirect Payroll Savings FAQs.
Converting Paper Bonds to Electronic Form
A new program called SmartExchangeSM allows TreasuryDirect account owners to convert their Series E, EE and I paper savings bonds to electronic securities in a special Conversion Linked Account in their online account.
Savings Bond History
Over the years, United States government has issued several series of bonds. Series E bonds were issued from 1941 to 1979. In 1980, Series EE and HH bonds were issued — EE bonds are still available, but HH bonds are no longer issued. Series I bonds were introduced in 1998. The different series results from slight differences in the characteristics of the bonds, including different terms of maturity, different methods of calculating the interest, and whether the bonds are issued at face value or at a discount.
Series EE Bonds purchased on or after May 1, 2005, earn a fixed rate of return. EE Bonds purchased between May 1997 and April 30, 2005, were based on 5-year Treasury security yields and earned a variable market-based rate of return.
- Lower Limits per Year for Purchasing Savings Bonds — Starting January 1, 2008, the total amount of savings bonds will be limited to $20,000 per year — $5,000 each for the Series EE bonds and Series I bonds purchased online, and another $5,000 for each series in paper bonds bought at a bank. Previously, the limit was $120,000 per year.