What are Savings Bonds?

Savings bonds are interest-bearing bonds that are issued by the federal government of the Unites States. Unlike bonds that are traded in the securities markets, savings bonds cannot be transferred once purchased, and are in this sense non-transferable. Many savings bonds are sold at less than their face value, leaving plenty of room for interest to accrue over a period of many years. Because they represent government obligations, savings bonds are considered to be one of the safest investments in the world, although their rate of return fluctuates periodically based on prevailing interest rates and inflation data.

The original savings bonds were created by the U.S. government to finance American involvement in World War I. There are two types of savings bonds that are still available; the series EE and series I bonds. Series EE savings bonds pay a rate of interest that varies periodically, but is calculated as 90% of the average yield on five-year Treasury securities over the past six months. In other words, every six months, the average yield of a five-year Treasury security is calculated for the time since the last calculation. If the result comes out to five percent, for instance, then the new yield on series EE bonds would be 90% of that, or 4.5%.

This changes for bonds issued in May 2005 or later, which pay a fixed rate of interest, somewhat like a certificate of deposit (CD). Series EE bonds are designed to be purchased by individuals, as opposed to institutional investors, and their interest is taxed only at the federal level. Savings bond interest is calculated monthly, but it is not paid until the bond is redeemed, at which time the interest becomes taxable.

Series I bonds are the second type of savings bonds that are commonly issued. Their yield also fluctuates, but this is based partly on inflation indices rather than interest rates elsewhere. The other part of the interest paid on a series I bond is a fixed rate that stays constant over the lifetime of the bond. New rates are calculated in May and November of every year.

Beginning in 2002, the U.S. government began to take steps to dramatically simplify savings bonds in general. The marketing offices for savings binds were closed, and their interest rates were lowered. In 2004, the series HH bond was phased out, so that it is no longer issued, but those that still exist will be allowed to mature. Series HH bonds were slightly different from the other two types, in that their interest was compounded semiannually, rather than monthly.