U.S. savings bonds are not nearly as popular as they have been in the past. Once a favorite gift of grandparents and one of the most popular vehicles for long-term savings, low interest rates have made these investment options less attractive.
Yet there are still some benefits to holding U.S. savings bonds. Here’s an overview of the advantages and disadvantages of savings bonds.
U.S. savings bonds: an overview
Saving bonds are essentially I.O.U.s from the government. They are backed by the full faith and credit of the U.S. Department of the Treasury, which means they are essentially risk-free.
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Americans used to be able to purchase savings bonds knowing that their investment would double in value within 10 years or less. That was during an era when interest rates were much higher.
Savings bonds accrue interest each year, but that interest isn’t paid out until it is redeemed or it reaches maturity. Today the U.S. Treasury adjusts a bond’s value to double the original issue price after 20 years if rates are low enough that interest payments have not doubled the bond’s value.
Types of U.S. Savings Bonds
There are two types of savings bonds offered today:
- Series EE US Savings Bond: These bonds grow at a fixed interest rate throughout their lifetime, allowing you to know for sure how much you’ll be paid at maturity or redemption.
- Series I US Savings Bond: These bonds also offer a fixed interest rate, but that rate is combined with another interest rate that is tied to the rate of inflation. Occasionally inflation drops into negative territory, but the rate of return on the bond bottoms out at 0 percent.
The benefits of U.S. savings bonds
The main advantage of investing in saving bonds is that you can be sure your money is safe. But there are some other advantages too:
- Low minimum investment. Unlike some other types of cash investments, you can purchase saving bonds with very small amounts of money as low as $25.
- Tax benefits. Interest earned on savings bonds is exempt from state and local taxes. Moreover, you don’t need to pay federal taxes on interest earned until a bond is cashed or mature. If you use the bond to pay for college the interest earned might be exempt from federal taxes.
- Protection from inflation. Series I bonds can be a good way of protecting the purchasing power of your money, especially at a time of high inflation.
- No fees or expenses. Unlike many other common methods of long-term saving, there are no ongoing expenses associated with owning saving bonds.
The drawbacks of U.S. saving bonds
The major disadvantage of savings bonds is their low rate of return. You may be able to find higher interest rates from a range of other conservative investments, such as high-yield savings accounts that also have the backing of the U.S. government.
Beyond the prospect of low returns, however, the inability to redeem savings bonds within a year of purchasing them can make them less appealing. What’s more, if you redeem within the first five years you’ll lose the interest earned during the last three months. It’s fairly common for people to need to tap into their long-term savings to cover unexpected expenses, so these restrictions, along with the low interest rates offered, are reason enough to think twice before investing in savings bonds.
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