U.S. Savings Bonds

/ October 15, 2011

Financial Plan & Insurance - iStockPersonally, I have never been one to purchase U.S. Savings Bonds. Nor have I received any as gifts. However, I have worked with many clients that one way or the other, have many Savings Bonds. When helping these clients with their estate plan, I have learned more than I ever imagined I would about Savings Bonds: what they are, how they’re issued, what their rate of return is and how to have them reissued if need be. I now share all of that information with you, our loyal Epilawg readers.

History

Savings Bonds are debt securities issued by the U.S. Department of the Treasury to help pay for the U.S. government’s borrowing needs. First created to help finance World War I, U.S. savings bonds are considered one of the safest investments because they are backed by the full faith and credit of the U.S. government; the registration on the bond is a contractual relationship between the owner and the United States Treasury.

In 2002, the Treasury Department started changing the Savings Bond program by lowering interest rates and closing its marketing offices. As of January 2011, Treasury stopped mailing paper bonds through payroll deduction programs in favor of individuals buying bonds online. And now, investors who want to buy Savings Bonds after December 31, 2011 will need to purchase them electronically through TreasuryDirect, a Web-based program offered by the Treasury Bureau.

Types

Series EE Bonds. These bonds are available in paper and electronic versions. In both cases, you cannot buy more than $5,000 (face value) during any calendar year. Series EE Bonds purchased on or after May 1, 2005, earn a fixed rate of return, letting you know what the bonds are worth at all times.

Paper EE bonds are purchased at a discount of half their face value, so you’ll pay $25 for a $50 bond. Paper EE bonds increase in value as the interest is added to the principal. When paper EE bonds mature in 30 years, you’ll receive all of the money you paid for the bonds originally plus all of the interest.

Electronic EE Bonds are sold at face value, so you’ll pay $50 for a $50 bond. The bond is worth its full value upon redemption. The interest is issued electronically to a designated account.

Series I Bonds. Like EE Bonds, I Bonds are available in paper and electronic versions. These bonds are sold at face value and you can buy up to $5,000 (face value) in any calendar year. Series I Bonds offer a fixed rate of interest, adjusted for inflation.  Therefore, while you own them they earn interest and protect you from inflation.

Differences. The biggest difference between EE and I Bonds is the rate you receive on your bonds. Rates for EE Bonds depend on the issue date and are either a fixed rate of return or a variable rate based on 90% of 6-month averages of 5-year Treasury Securities yields, while rates for I Bonds are calculated by combining fixed rates of return and semi-annual inflation rates based on the consumer price index.

Who

Individuals, corporations, associations, public or private organizations, and fiduciaries can own paper Series EE and I Bonds. Effective April 2009, individuals and various types of entities including trusts, estates, corporations, partnerships, etc. can have TreasuryDirect accounts and own electronic savings bonds.

You can own U.S. Savings Bonds if you have a Social Security Number and you are a:

  • Resident of the United States.
  • Citizen of the United States living abroad (must have U.S. address of record).
  • Civilian employee of the United States regardless of residence.
  • Minor. Unlike other securities, minors may own U.S. Savings Bonds.

Tax Advantages

Interest earned on Savings Bonds is exempt from state and local income taxes. Additionally, you can defer federal income tax until you redeem the bonds. Plus, special tax benefits are available for education savings. If you qualify, you can exclude all or part of the interest earned on Savings Bonds from income when the bonds are redeemed to pay for post-secondary tuition and fees.

Interest Rates

As mentioned above, Series EE Bonds issued May 2005 and after earn a fixed rate of interest. The fixed rate is determined by adjusting the market yields of the 10-year Treasury Note by the value of components unique to Savings Bonds, including early redemption and tax deferral options. Rates for new issues are adjusted each May 1 and November 1, with each new rate effective for all bonds issued in the six months following the adjustment. Interest is added to these bonds monthly, rather than every six months, and is compounded semiannually.

At a minimum, the U.S. Treasury guarantees that an EE and I Bonds’ value will double after 20 years, its original maturity, and it will continue to earn the fixed rate unless a new rate or rate structure is announced. If a bond does not double in value as the result of applying the fixed rate for 20 years, the U.S. Treasury will make a one-time adjustment at original maturity to make up the difference. Series EE and I bonds earn interest for 30 years.

Reissuing

For both paper and electronic bonds, there can be a sole owner, co-owners and beneficiary designations. For any of these roles, reissuing may be necessary. Reissuing is a transaction requested to re-register savings bonds.  Reissuing is necessary in various situations, including:

  • Updating a beneficiary designation
  • Naming a co-owner
  • A surviving owner wants to remove the name of a deceased co-owner
  • Changing a name due to marriage, divorce, annulment or court order

The reissued bonds retain the same issue dates and interest earnings as the original bonds.

Redemption

A three-month interest penalty will be applied to bonds held less than five years from issue date. This rewards longer-term bond holders who benefit from higher 5-year rates over the full life of the bond. For example, if you buy a bond and redeem it 24 months later, you’ll get back your original investment and 21 months of interest. The value of the bond would be based on the announced rates applied over the initial 21-month period.

As I have learned, this is a ton of information, so do not hesitate to contact your accountant, financial advisor or attorney with questions.