What are Savings Bonds?

The United States established savings bonds, known then as “warbonds,” in 1941 to help to pay for the huge expenses it incurred duringWorld War II. Today, savings bonds still help keep the government wheelsrunning smoothly. Savings bonds are a debt instrument of the U.S.Government, issued as savings certificates to individual investors in smallamounts. Savings bond certificates bear face value denominations rangingfrom $50 to $10,000. Since they are backed by the full faith and credit ofthe Federal Government, savings bonds are among the safest investmentspeople can find.

The U.S. Government is unlikely to default; and even if you lose yoursavings bond certificate, the Government will often replace it, especiallyif you can provide such information as the serial number, issuance date,address and Social Security number of the owner. Another major advantageof savings bonds is that they are an accessible investment for almostanyone, since you can buy savings bonds in amounts as low as $25. Forinstance, you can buy a $50 Series EE bond for $25, and at maturity you canredeem it for $50. As a result, savings bonds still make good gifts forchildren planning to attend a college or technical school.

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That is not all.Savings bonds have at least two more advantages. They can provide a taxshelter; for instance, you would not pay income tax on the earnings ofSeries EE bonds until you redeemed the bonds. In addition, savings bondsare easy to acquire from a variety of resources. Besides being extremelyeasy to acquire, a savings bond offers another attractive purchasingfeature: no seller’s fees.

Unlike stock purchases, there are no fees orcommissions that add to the purchase price.Where do you buy Savings bonds? Savings bonds are sometimes availablethrough a payroll deduction plan at work. Also you could purchase them at avariety of government offices and financial institutions: Banks, CreditUnions, Federal Reserve banks and branches – by phone or mail only (TheFederal Reserve no longer provides a walk-in service), and the Bureau ofPublic Debt.Anyone who bought or received a savings bond before 1980, they owned aSeries E or Series H savings bond.

That year, Series EE and Series HH bondsreplaced the original series. The two current series offer a differentmaturity and interest rate. In 1998, the U.S. Government introducedinflation-indexed Series I bonds. The U.S.

Government issues Series EEbonds at one-half their face value, which ranges from $50 to $10,000. Atmaturity, you can redeem the bonds at their face value. You may buy up to aface value maximum of $30,000 in Series EE bonds annually. Series EE bondsearn interest for 30 years. Series HH bonds earn interest for 20 years.You can acquire Series HH bonds only through an exchange of your Series Eor Series EE bonds.

A minimum acquisition is $500. Other denominationsissued are $1,000, $5,000, and $10,000. Unlike Series EE bonds, youpurchase Series HH bonds at their full face value and thereafter receiveregular interest payments. Series I bonds also are sold at their full facevalue, beginning with a minimum denomination of $50.

Other denominationsare $75, $100, $200, $500, $1,000, $5,000, and $10,000. Like Series EEbonds, you receive the interest earned when you cash the bond. I bonds earninterest for 30 years.The current rate on Series EE bonds is 2.

61 percent interest, throughApril 2004. New interest rates are announced twice a year and take effectMay 1 and November 1. If held for five years, Series EE bonds pay 90percent of the six-month average yield on five-year Treasury securities.

Earnings vary for Series EE bonds issued from 1980 to 1997. Many Series Ebonds have stopped paying interest. You receive the interest earned alongwith your principal when you cash in the bond. Series HH bonds pay a fixedrate of interest from the date you purchase the bonds.

In August 2004 itwill be the last issue month for HH/H bonds. After August 31, 2004, no onewill be able to reinvest on HH/H or exchange their EE/E bonds for HH bonds.Series I bonds bought from May 1, 2003 through October 30, 2003 will earn4.66 percent interest for the first six months. The rate is a combinationof a fixed rate of 1.1 percent (fixed for the life of the bond) plus anadjustable rate (adjusted six months) based on inflation. You receive theinterest earned along with your principal when you cash in the bond. Thefederal government developed Series I bonds to assure investors a rate ofreturn above inflation.

Historically, some savings bonds have, in reality,lost purchasing power during periods of high inflation.While savings bonds are intended to be long-term investments,eventually the time will come when we want to redeem them. Maybe we needthe money to return to school, for a long-awaited retirement cruise, or fora hundred and one other reasons. Generally, the easiest way to redeemsavings bonds is through a local bank, credit union, or other financialinstitution, although you also can contact the U.S. Bureau of Public Debtor the nearest Federal Reserve Bank. Redeeming savings bonds at a localfinancial institution is a simple and straightforward process. If you arenot the owner of the bonds, you will also have to establish that you areentitled to cash them.

For example, you may be listed as a beneficiary onthe bonds of someone who has died and in addition can provide a deathcertificate of the former bond owner. In addition, you can redeem yourbonds for their full value, unless you have held them for less than fiveyears. In that case, there is a penalty equaling three months’ interest.For example, if you redeemed a Series EE bond that you had held for twoyears, you would receive interest for 21 months-not 24 months.In the other hand, before cashing your Series EE bonds, you have theopportunity to exchange them for Series HH bonds instead, especially ifthey are near maturity. Series HH bonds will pay twice-yearly interestpayments.

In addition, exchanging Series E or EE bonds for HH bonds willcontinue to provide a tax shelter for the funds invested (Series I bondsmay not be exchanged for HH bonds.) In order to exchange Series E or EEbonds, they must be at least six months old (12 months old if purchasedFebruary 2003 and after). They also must be currently worth at least $500and must be exchanged within one year of maturity. Since Series HH bondsare available only in multiples of $500, you can elect to either receivesome of your Series E or EE investment in cash or pay additional funds inorder to acquire the HH bonds. For instance, if you want to exchange SeriesEE bonds worth $1,200 for Series HH bonds, you can receive either $1,000 inHH bonds and $200 cash or $1,500 in HH bonds with an additional payment of$300. There is no limit to the number of HH bonds own. The easiest way toexchange Series E or EE bonds for Series HH bonds is through a localfinancial institution, which can help with the paperwork and transmit yourapplication to a Federal Reserve Bank.

Or, you can get an application andfile it yourself with the nearest Federal Reserve branch.While savings bonds do not earn high interest, the low interest rateis sometimes compensated by favorable tax terms. What specifically are thetax advantages? For starters, you do not pay any state or local taxes onthe earnings of any savings bonds you own.

While you must pay federal taxeson the earnings of Series HH bonds in the year that you receive thatinterest, you can defer earnings and taxes on Series E, EE and I bonds forlong periods. Also, you can hold Series EE and I bonds for 30 years. Afterthat period, you can exchange Series EE bonds for HH Series bonds and thenhold them for another 20 years.

After 20 years, you must redeem the HHbonds and finally pay any taxes owed on the earnings from the old EE bonds.If you buy Series EE or Series I bonds in the name of your child and redeemthe bonds while the child is still your dependent, you will pay taxes onthe earnings at the child’s rate. The child’s rate may be 0 percent if thechild’s total unearned income is $700 or less; in any case, it is almostcertainly less than your tax rate.In 1990, the Treasury Department established the Education Bond Program,which exempts savings bond earnings from federal tax if the bonds areredeemed to pay for qualified education expenses. To qualify for thisprogram, an adult age 24 or older must buy the bonds. He or she then mustredeem them and document tuition and certain other education-relatedexpenses.

(Room, board, and books are not qualified.) If the value of thebonds redeemed is greater than the qualified expenses, only the proportionused for qualified expenses is tax-free. The full exclusion is also onlyavailable to single taxpayers with annual income below $53,100 and marriedpersons filing jointly with income below $78,350. Single taxpayers withincome of $67,250 or more and married persons filing jointly with income of$108,350 or more are ineligible for this program.

As you can see, there can be many advantages to practice of givingsavings bonds each year or buying savings bonds. Besides offering severaltax advantages, savings bonds can provide a reasonable, inflation-indexedreturn and a steady investment vehicle for the long term and not to mentionthe safety and backing of a U.S. Government-issued security.