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What are U.S. savings bonds?
United States savings bonds are debt securities bought by people to pay for certain government programs. Essentially, when she buys a U.S. savings bond, the buyer is loaning money to the government with a guaranteed promise that she’ll earn back the face value of the bond plus interest in the future. Such savings bonds are backed by the U.S. government, meaning that there’s virtually no possibility of the buyer losing her investment.
During World War II, the U.S. government began to issue savings bonds to help finance its military effort. The purpose of bonds used to be that the buyer would pay less than face value and the bond would mature over a number of years until it was worth its face value plus interest. However, the government now sells all bonds at face value, which lets them accrue more interest over time but means that the buyer has to pay more upfront. Bonds can be given as a gift as well as purchased for oneself, and all U.S. savings bonds are backed by the government.
Since the war, there have been various types of U.S. savings bonds issued by the government, but in recent years those have narrowed down to two: Series EE bonds and Series I bonds. Just a few differences separate the two types of bonds.
The most important difference is the rate, or coupon, at which they earn interest. EE bonds earn a fixed rate of interest while I bonds earn a fixed rate plus an inflation rate, and that combined rate is much higher. However, after 20 years, the EE bond is guaranteed to double in value via a one-time payment from the Treasury that effectively increases the interest rate to 3.5 percent.
Since 2012, the Treasury has required people to buy bonds directly from its website, TreasuryDirect.gov, except in the case of an I bond, which can be purchased in paper form if bought with a tax refund. Both types of bonds require a minimum payment of $25 and limit annual bond purchases to $10,000 per Social Security number. Interest accrues every month and compounds every six months, so that the bondholder even earns interest on interest. The bondholder can’t redeem the bond for 12 months after purchasing, and if she redeems it within the first five years she’ll forfeit three months of interest.
U.S. savings bonds have two tax advantages: interest earned on them is only subject to federal taxes, not state or local taxes; and when used for qualified educational expenses, interest earned on U.S. savings bonds may be entirely tax exempt.
After 30 years, U.S. savings bonds stop earning interest, at which point the bond is essentially free money for the government. A 2009 study showed that an estimated $17 billion in wartime U.S. savings bonds have never been redeemed.
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U.S. savings bonds example
Jordan buys a Series EE U.S. savings bond for his newborn grandson to help pay the grandson’s college tuition. He pays $10,000 for it, meaning that by the time his grandson is in college the savings bond will be worth at least $20,000. Jordan can withdraw the money tax-free because he’s using it for his grandson’s education.