How Savings Bonds Work

How Savings Bonds Work

Savings bonds come in two types, which are Series EE and Series I bonds. They are issued by the United States Department of the Treasury and provide government funding. The government awards interest in return.

Savings bonds may be used at banks and credit unions, although it is less common for these entities to sell bonds. Bonds can be purchased either in paper format (this now applies only to Series I bonds) or electronically. They are long-term investments in the United States federal government, and they're considered to be one of the safest types of investments. In exchange for letting the government borrow an individual's money for essential operations, the government pays the bondholder interest. Interest rates accrued through bonds are primarily based on economic function. If the economy thrives over a period of time, an individual will receive a higher interest payment (and more significant earnings) through the bond than if the economy performs poorly.

Types of Bonds
Series EE and Series I bonds have some similarities as well as notable differences. Interest rates for each can amount to the same regardless of the bond's format (paper or electronic). However, the way in which the two types of bonds generate interest is different. Series EE bonds issued during May 2005 have a fixed interest rate of return, according to the United States Department of the Treasury. However, Series EE bonds issued between May 1997 and April 2005 earn variable rate interests. The interest rate for bonds issued during this period of time is based on just less than 100 percent of Treasury Security yields over a five-year time period.

Series I bonds, in contrast, have a combined interest earning created from several sources. In these bonds, interest accrued is a combination of a fixed rate of return, which the bondholder is aware of when he or she purchases the bond, as well as inflation rate. Inflation rate, calculated twice each year, is calculated based on CPI-U.

How Bonds Function
Despite having differences in the way they collect interest, Series EE and Series I bonds function in similar manner. Both have the same face value, which means that $75 spent on each type of bond gives the bondholder a bond that is equal to $75. Electronic bonds are available in the same amount for both types of bonds. In both instances, electronic bonds are issued in amounts of $25. A person spending $50 on each type of bond, for instance, gets two Series EE and Series I bonds of equal value. Each year, the United States Department of the Treasury sets a maximum limit of $10,000 that a person can spend on Series EE bonds.

Bond purchases are tracked by Social Security numbers, so a $10,000 maximum is assigned to each Social Security number listed in the government's database. People can outright purchase up to $10,000 in Series I bonds, and they can also purchase an additional $5,000 worth of Series I bonds through tax refunds. Regardless of which type of bond people choose, they must wait one full year before cashing in the bond. Interest in both types of bonds is accrued monthly and compounded for up to 30 years, according to the Treasury Dept.

Bondholders can cash in their bonds for money to use for personal expenses. However, they should wait for five years before doing so to avoid a penalty. Bonds used for certain expenses, such as education, may be excluded from income.