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What are Savings Bonds and their Tax Benefits?

By: , dated January 25th, 2013

Savings bonds are also issued by the U.S. treasury. They differ from other Treasury securities in several ways. Savings bonds are non-marketable, meaning that they cannot be traded after they are purchased from the government; therefore, there is no secondary market for savings bonds. The tax benefits associated with savings bonds are significant. Like all treasury securities, they are exempt from state and local taxes, but in the specific case of savings bonds, all federal taxes may be deferred until the bond is redeemed. Therefore, even though interest will accrue, no taxes will be due until that money can be accessed. Additionally, if the money received at redemption is used to pay tuition expenses for the holder, a spouse or a dependent in the same year, the interest earned may be exempt from federal taxes as well. Because savings bonds can be redeemed at any time without penalty once they have been held for six months, they are extremely liquid even without a secondary market. Savings bonds are very easy to purchase with a Treasury Direct account (described earlier). Money can also be regularly deducted from paychecks and placed in savings bonds, or, with the “Easy Saver” program, money can be automatically deducted from a bank account at regular intervals. The bonds can also be purchased at banks or at the website of the Bureau of Public Debt. Interest rates earned on savings bonds are adjusted in relation to the market every six months.

There are three important types of savings bonds currently being issued:

Series EE bonds

EE bonds are purchased for half of their face value, and they can be redeemed for their facevalue at maturity, which is determined by the interest rate at the time of purchase. However, they can be redeemed at any point after six months for the current value without incurring a penalty. Interest accrues on the first day of each month, making that the best day to redeem savings bonds. All interest and principal is paid only at redemption. Denominations range from $50 to $10,000. At maturity, the bond will automatically enter extended maturity and earn interest according to rates at the beginning of that period. EE bonds will continue to earn interest for 30 years after they are purchased. Once they have reached maturity, EE bonds may be exchanged for Series HH bonds in order to continue to earn interest and further defer federal taxes. An individual can purchase up to $30,000 face value in savings bonds in one year.

Series HH bonds

HH bonds are acquired by exchanging EE bonds for them at maturity. HH bonds are available in denominations ranging from $500 to $10,000 and, unlike EE bonds, are sold at face value. They pay interest every six months and continue to earn interest for 20 years. The interest rate at the time of purchase is locked in for the first 10 years that the bond is held. After ten years, HH bonds enter extended maturity and the new interest rate is determined by the rate assigned to new bonds issued at that time.

Series I bonds

I bonds are inflation-indexed savings bonds that pay a fixed interest rate for the life of the bond and a variable rate that tracks inflation as measured by the Consumer Price Index. They are sold at face value and pay interest every 6 months. The inflation-adjusted portion of the return is recalibrated semiannually. Up to $30,000 may be invested in I bonds each year by a single individual. I bonds pay interest for up to 30 years, but there is a penalty equivalent to 3 months of earnings for redeeming the bond before 5 years.

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