How-to Guides

U.S. Savings Bonds offer investors both a government guarantee of principal and interest as well as a significant income-tax shelter. They are frequently purchased as gifts for minor children, for funding a child's college education, or as a conservative investment vehicle for retirement income.
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U.S. Savings Bonds represent loans to the federal government to be repaid in full, with interest, at a specified future date known as the maturity date. Two series of savings bonds are currently issued: Series I and EE. Series I bonds are inflation-indexed bonds used for savings. This article focuses on Series EE bonds, and their predecessors, Series E savings bonds, which are typically purchased as gifts for children or to fund future college costs or for retirement income.

Series EE bonds issued today in paper are sold at a 50% discount to face value (the amount paid at maturity). For example, a Series EE paper bond issued today with a face amount of $1,000 costs $500 and will be worth $1,000 in 17 years. Bonds held after the 17-year maturity date will continue to earn interest semiannually for another 13 years. Electronic bonds are issued at face value. New bonds purchased after April 30, 2005, receive a fixed rate of interest for the life of the bond based on the interest rate in effect at the time of purchase.

Series E and EE savings bonds offer certain tax advantages to investors. The interest income from them may be federally tax deferred and is exempt from both state and local income taxes. Interest on savings bonds redeemed to fund college tuition and books is not taxable if certain requirements are met.

Savings bonds are nontransferable and payable only to the owner, the co-owner, or a death beneficiary. If an owner wishes to give a savings bond to another, he or she should have it reissued in the donee's name. But note that the reissuance could trigger a taxable event. The bonds cannot be assigned or used as collateral for a loan. Bonds may be purchased by mail or over the counter at banks, savings and loan associations, and other local agencies. (They also may be redeemed at these same locations.) Or you can buy bonds online at www.treasurydirect.gov.

Put Your Patriotism to Work

In December 2001, the U.S. Treasury unveiled Series EE savings bonds designated as Patriot Bonds. The funds raised by the bonds contribute to the U.S. government's overall effort to fight the war on global terrorism.

Patriot Bonds are sold in the same denominations as the EE Bonds. The issue price is 50% of the denomination for paper bonds (face value for electronic bonds). Interest accrues on a monthly basis and is compounded semiannually. They can be redeemed anytime after six or 12 months, depending on the issue date. Bonds redeemed before five years receive a three-month interest penalty.

You can purchase Patriot Bonds through financial institutions or at www.treasurydirect.gov.
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Series E Bonds, first issued in May 1941, were withdrawn from sale in 1980 and have been replaced by Series EE Bonds. They were issued in denominations of $50, $75, $100, $200, $500, $1,000, and $10,000. The purchase price was 75% of the stated denomination. Series E Bonds were redeemable any time after two months from the issue date.

Interest on an E Bond accrues through increases in redemption value at the end of each half-year period from the issue date, with an additional increase for the remaining fraction of a half-year, if any, to maturity of the original or extended period. The increases are graduated upward for each succeeding period. Thus, the average annual interest yield continues to rise the longer the bond is held. All Series E Bonds now carry automatic extension privileges, with those issued from December 1965 through June 1980 permitted two 10-year extensions. Interest on E Bonds is subject to estate, inheritance, gift tax, and federal income tax, but is exempt from state and local income tax. If used to finance education, however, it may be excluded from federal income tax.

Series EE Bonds have replaced the formerly issued Series E Bonds. They are sold in the same denominations as the E Bonds, with the addition of one at $5,000; electronic bonds may also be purchased in $25 denominations and sold at face value. The issue price for paper bonds is 50% of the denomination; electronic bonds are issued at face value. Series EE Bonds may be redeemed at any time after six or 12 months, depending on the issue date. Interest on EE Bonds accrues through increases in redemption value, which are graduated upward for each succeeding period. Thus, on the EE Bond also, the average annual interest yield continues to rise the longer the bond is held. EE Bonds issued in May 1981 or shortly thereafter, for example, produce average yields of approximately 6.78% per year, compounded semiannually, if held to the original maturity dates. Rates are reset every six months based on Treasury bill yields. Series EE bonds purchased after April 30, 2005, have a fixed rate of interest for the life of the bond based on the interest rate in effect on the date of purchase.

Series EE Bonds can earn a competitive interest rate when held to maturity. This interest may be deferred for tax purposes until redemption or it may be declared annually. The limit of EE Bonds that may be purchased and held in the name of any one person in any one calendar year is $30,000 (face amount) or $15,000 total cost. For the purposes of computing this limit, bonds issued to co-owners may be applied to the holdings of either or apportioned between them.

Interest on Series EE Bonds is subject to the same taxes as interest on Series E Bonds. An accrual basis owner includes the annual increment of the bond in his or her gross income each year. A cash basis owner realizes no income from the bond until its redemption or maturity, and then reports the full gain as ordinary income. Alternatively, the cash basis owner may elect to report the annual increment each year, provided he or she makes a binding election covering all of his or her Series E, EE, or Series I bonds.

For More Information...

• The Bond Bible, Marilyn Cohen, Prentice Hall Press
• The Bureau of the Public Debt, www.savingsbonds.gov

When used for juvenile gifts, a 1040 tax form should be filed for the child each year following the gift, declaring the annual accrued interest. As a result, when surrendered, there would be no taxable income until the child's (age 18 and younger) total investment income exceeds the floor, below which no Federal tax is levied (currently $850). The child should be listed as the sole owner, with a parent or another child as beneficiary.

No matter how much income a child reports from Series EE Bonds or other sources, the parents are still entitled to claim a dependency exemption if: they provide over half of the total support for each tax year the child is under 19; the child is over 19 and a full-time student for at least five months; or the child does not claim an exemption on his or her tax return.
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For all U.S. Savings Bonds over 30 months old, interest is compounded semiannually. Each bond can increase in value at a different time, and the month of increase for many bonds is generally not the month of purchase. Since the interest is not posted daily like a bank savings account, you could forfeit up to six months' interest on each bond you own when redeeming them.

The interest rate that applies to each bond varies, depending on when the bond was purchased. Knowing the specific rates your bonds are earning is essential if you want to compare your bonds to other investments, or if you are going to redeem some of your bonds, but are not sure which ones to select.
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