How Do Savings Bonds Work?
Perhaps you received college savings bonds—or another type of savings bond—as a gift from a relative when you were younger. What is it for? When can you cash it in? Exactly how do savings bonds work?
Savings bonds are securities that the United States Treasury Department issues to you. It's a little different from an investment, though it bears many similarities to one; in return for using the money from your savings bond, the government pays interest on the initial value of the bond, meaning it will gain value over time.
The most common type is Series EE savings bonds. Initially purchased at a discount of their face value, Series EE bonds mature after 20 years, at which point the money they represent will have doubled in value, according to the U.S. Treasury.
You can cash in Series EE bonds after one year, but if you do so before five years, you will incur a penalty of three months' interest.
Series I bonds are similar, but the interest rate is calculated a bit differently. The bond will accrue interest with a fixed rate plus the rate of inflation calculated during six-month intervals.
This probably sounds pretty complicated. Basically, though, if you're expecting high inflation rates in the coming years, Series I bonds are the better choice, but if you're expecting lower inflation rates, Series EE savings bonds are a better bet.
How do I cash in a savings bond?
You can't sell, trade, or give away any type of savings bond, so you will need proper documentation in order to receive the money value of the bond and your interest. If you have electronic savings bonds, the process is as easy as logging into your account via the TreasuryDirect website and following the directions there.
If you want to cash in paper bonds, you'll need to take them to a financial institution where you've had an account for at least six months. If you haven't had an account at any financial institutions for that long, then you'll need to use a government-issued photo ID, such as your driver's license, to prove your identity. If you are using an ID to prove your identity, you may only cash in up to $1,000 worth of savings bonds. If a child who is too young to sign her name is the owner of the bond, a parent or guardian may redeem it on her behalf.
What are the benefits to savings bonds?
Most savings bonds are subject to federal income tax, but not state and local tax. You can also delay claiming interest income until cashing in the bond, since you won't be earning interest until you redeem it.
If you use the money and interest you earn from a savings bond for certain higher education-related expenses you may be able to exclude it from income tax as well.
Savings bonds are considered very low-risk, since they're backed by the faith and credit of U.S. government. However, since they take a long time to mature, you're probably not going to make bank on them. You can find out how much your bonds are worth today on the TreasuryDirect website.
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