How Do Savings Bonds Work?

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Modern U. S. savings bonds are essentially a loan from purchasers to the U. S. government. They are purchased online at face value through the U. S. Department of the Treasury and accrue annual interest for up to 30 years until they are cashed in. Bonds may be cashed in as soon as six months after purchase, but bonds cashed in early are penalized the last three months' worth of interest.

The two types of savings bonds, the EE and the I, differ primarily in how interest is calculated. The EE earns a rate based on 5-year Treasury security yields, while the I earns a variable rate indexed to inflation. Both are available for purchase online at Treasury Direct, a government website. Bonds purchased today are electronic-only. According to Susan Tompor at USA Today, the Department of the Treasury ceased issuing paper bonds in 2012.

Savings bonds often earn low interest relative to other securities, but that does not necessarily mean they are worthless. The Internal Revenue Service explains in its Publication 970 that Series EE and I savings bonds can be used as tax-free savings instruments for certain college expenses, including tuition and fees. Dorothy Rosen at adds that interest earned on U. S. savings bonds is exempt from state and local tax in all cases, and even federal tax is deferred until the bond is cashed in.