How do Savings Bonds Work

You might have heard of it being given as gifts to children or used to save for college education bills. However, how many of us truly know what saving bonds are and how they work? Before we can look into how do savings bonds work, let us first try to understand more about this type of investment.

What are Saving Bonds
Saving bonds are securities that are issued by the United States Treasury Department and offered at major banks and credit unions. While for us it may be the safe means of investing our hard-earned money, saving bonds are used primarily for funding the dollars for the US government. In return the government pays you interest for the investment based on the denomination of the savings bond. However, it is important to note that saving bonds are not transferable or marketable and cannot be bought or sold by any organization or person other than the United States Treasury. After a specified holding period or post maturity, these registered securities can then be encashed. There are essentially two types of savings bonds issued, the EE savings bonds and the I bonds which are the newer version of savings bonds.

What is the Interest Rate of Savings Bonds
Interest rates of the savings bonds may differ based on the fluctuation of the economic interest rates. The value of the bond may differ based on the kind of bond purchased and when it is cashed. For example the EE bond that replaced the earlier Series E bonds are sold at a 50% discount of the face value. The interest is accrued each month which is stopped after the duration of thirty years. However, unlike the I bonds where the redemption value never decreases, EE bonds if encashed before five years, incur a three month penalty. The current interest rates for the saving bonds are displayed on the U.S. Treasury website. This is updated on May 1 and November 1 every year.

Is there a Tax Advantage
Saving bonds are subject to Federal Income taxes. However the holders of saving bonds may pay the income tax annually, or defer the tax until the bond matures or the bond is cashed out. Also, there are no state and local taxes imposed on the saving bonds. One other advantage of saving bonds as an investment is that there is no income tax levied on the bonds if it is used for the purpose of higher education and thus can placed in the child's name. Known as Educational Tax Exclusion or Educational Savings Bonds, these instruments can help you exclude the income from the taxes. However, the higher education claims need to be qualified at the time of redemption.

How Safe are the Investments
Backed by the US government, the saving bonds are an appropriate low risk financial instrument. However, before you invest in these bonds, you need to keep certain things in mind. Although the interest rates might be higher than savings accounts, bonds do have a number of disadvantages. Firstly, the interest rates are quite low as compared to other long-term investments like stocks. Additionally there are liquidity concerns where penalty is charged if the investment is withdrawn before five years.

Knowing how saving bonds work can help you make better decisions about investing in these securities. If security and long term safety is what you are looking for, then this investment option should work great for you. However, how do saving bonds work for you in the future is based on the returns that you expect from it. So, if your entire motive of investment is to keep the principal amount safe, then saving bonds are a great option for you.