Bond, Savings Bonds.. How Do They Work?
Bond, Savings Bonds.. How Do They Work?
By Les Stephen
Many of us, especially if we are a little more advanced in age, have probably had experience with savings bonds. Maybe grandma bought you one when you graduated high school or hit that home run in Little League (this was me). Whatever the reason, it was undoubtedly the most boring thing you could receive as a kid. Having said that, it is an investment instrument, and you may own one, so it would make sense to know how they work.
Maybe we should first discuss, what is a bond?
A bond, simply put, is a loan; usually made by an investor to a borrower which is commonly a corporation or government agency. A bond could be thought of as an I.O.U. between the lender and borrower. Specific to our conversation, a savings bond, whether an EE bond or an I Bond, is a loan to the U.S. Government that is issued by the U.S. Treasury. When you buy one, you are lending money to the government. You can register yourself or someone else, even if they are a minor, as the owner or co-owner of a savings bond. Only a bond’s owner or beneficiary can cash it. This is why you can’t sell them to a friend; you must redeem them yourself. They have also changed lately because in the old days, you would be issued a paper bond that you could show off, but today, like most things, they are issued electronically.
The first type is an EE bond
You purchase it for 50% of the face value of the bond. For example, if you have a $100 savings bond, it was purchased for $50 and will gain interest for the next 20 years until it is worth its full, face value. If you hold on to it from there, it will still pay interest for the next 10 years and be worth more than the face amount. After that, no more interest will be paid. In my opinion the advantage is that it’s a very safe instrument; it kind of forces the beneficiary to hold it for a long period of time and not run to the bank and cash it out. The disadvantage is that your money is locked up for a long time at a low interest rate.
Next, a Series I savings bond
Which functions a bit differently. They are issued at a set interest rate and cannot be redeemed within the first year. From year 2 – 5 they can be redeemed, but with a 3 - month interest penalty. After 5 years, there are no penalties, and they continue to earn interest for the next 30 years if you want to keep it that long. The interest rate on an I Bond changes and it is a very complicated calculation. The advantages are that they are more liquid and may beat those high interest savings accounts you find online. The disadvantage is that they still have a relatively low interest rate, and that rate can change.
One thing to consider is that as of the time of this blog, both bonds are not subject to state or local taxes. If you would like more information you can go to the U.S. Treasury’s website *, to stay up to date on any state or local taxes. Good luck and thanks for reading, hoping grandma left you some great savings bonds after you hit your Little League home runs too!
The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.
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