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How Do Savings Bonds Work?
Maybe your grandma gave you a savings bond as a gift back in the day, and you’re wondering how to cash in savings bonds? Or maybe you’re interested in a risk-averse investment but need a little more information on how do savings bonds work? Whatever the case, savings bonds are a wonderful investment that comes with the full backing of the U.S. government.
What is a savings bond?
A bond is a financial instrument or asset class that represents a loan between an individual (you) and a company or government. Savings bonds are bonds that represent a loan from you to the U.S. government. The government uses savings bonds to help fund operations and manage debt. Unlike other assets, U.S. savings bonds can only be purchased directly from the government and cannot be transferred to anyone else.
Savings bonds are an attractive investment to some because they come with no risk and can help hedge against inflation. Since the bonds are backed by the U.S. government, you should have no fears of the borrower defaulting on the loan. Additionally, some types of U.S. savings bonds pay a fixed rate of return plus an added interest rate to account for inflation. If you’re worried about your wealth decreasing because of inflation, this is a great tool to mitigate that risk.
How does a savings bond work?
Different types of savings bonds have different nuances, but the general idea is the same. You purchase the bond for an agreed-upon amount of money. In return, you receive a return for allowing the borrower — in this case, the U.S. government — to hold onto that money and use it for an agreed-upon period of time. With many savings bonds, you will need to keep the bond until maturity to maximize the value. Withdrawing your money early could result in a penalty in some situations.
How do I purchase a savings bond?
When you want to purchase savings bonds, it must be done through the government and cannot be bought through any other markets. In the past, you could buy paper bonds through your bank or credit union. Today, though, savings bonds must be purchased through the Treasury Department’s website. You can open an account on the “Individuals” tab with the “Open an Account” link on the menu bar on the left-hand side of the page.
How to cash in a savings bond?
Cashing in a savings bond can be done directly through the Treasury Department’s website. The site offers extensive FAQ and information on the steps and nuances of how to redeem savings bonds. You may also be able to cash in your older paper bonds at some banking locations. The Treasury Department recommends reaching out first before trying. You may also need to bring proof of identity if you’re not an existing customer with the bank.
Types of savings bonds
There are two different types of savings bonds offered through the Treasury Department. Each has its own benefits and drawbacks to be aware of before investing.
- Series EE bonds: Formerly known as the Series E bond, the Series EE is the most common type of bond offered through the Treasury. The minimum purchase is $25, and the maximum annual purchase is $10,000. All Series EE bonds issued after 2005 earn a fixed rate of return. The Treasury guarantees that these bonds will reach maturity (double) by the 20-year mark. If you do cash in these bonds before five years, though, you will incur a three-month interest penalty. Series EE bonds cannot be cashed in within the first year.
- Series I bonds – This type of bond offers a fixed interest rate plus a variable rate added in to account for inflation. The minimum and maximum purchase amounts are the same as with Series EE bonds, except you can purchase an additional $5,000 in paper Series I bonds with your tax return. Because these bonds account for inflation, they can be a great investment if you’re anticipating higher inflation rates. If you’re anticipating low inflation, though, Series EE bonds may be the better bet.
Savings bonds vs. savings accounts
There are a few marked differences between investing in savings accounts and savings bonds. First, the liquidity of savings bonds in the first year is non-existent. With a savings account, though, you can access your money with a limit of six transactions per month. After the first year, you can cash in your savings bonds, but you may pay a penalty, depending on the time frame.
The big advantage of savings bonds, specifically Series I bonds, is that they are able to protect your savings from rising inflation where savings accounts cannot. The current fixed rate on Series I bonds is 0.00%, plus the inflation percentage updated semi-annually — current 0.53% — and the current U.S. savings bonds rates on Series EE bonds is 0.10%. Some high-yield online savings accounts are currently offering more attractive rates in the mid-1% range, but don’t account for inflation.
Savings bonds vs. CDs
Certificates of deposit are another savings instrument often compared with savings bonds and savings accounts. What’s nice about CDs and savings bonds compared to savings accounts is that you can lock in a rate for a fixed period of time. However, this rate with CDs will not change if inflation rises and erodes your savings potential. Series I bonds, on the other hand, will adjust for inflation to protect your money. Again, bonds may be a better investment in times of rising inflation.
The current rates on CDs fluctuate frequently but are on par with high-yield savings accounts in the mid 1s. It’s also important to note that some CDs have minimum investments of several hundred or thousands of dollars, where the minimum bond investment is $25.
Savings bonds vs. money market accounts
Money market accounts are a hybrid between checking accounts and savings accounts. They give you some of the flexibility and liquidity of checking accounts, while still offering higher returns and interest rates. If you’re looking for an account that will give you regular, albeit slightly limited, access to your funds, a money market account is a way to go. If you can leave your money untouched and are concerned about rising inflation, Series I bonds could be the better fit.