What are Savings Bonds?

The United States established savings bonds, known then as “war
bonds,” in 1941 to help to pay for the huge expenses it incurred during
World War II. Today, savings bonds still help keep the government wheels
running smoothly. Savings bonds are a debt instrument of the U.S.

Government, issued as savings certificates to individual investors in small
amounts. Savings bond certificates bear face value denominations ranging
from $50 to $10,000. Since they are backed by the full faith and credit of
the Federal Government, savings bonds are among the safest investments
people can find.

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The U.S. Government is unlikely to default; and even if you lose your
savings bond certificate, the Government will often replace it, especially
if you can provide such information as the serial number, issuance date,
address and Social Security number of the owner. Another major advantage
of savings bonds is that they are an accessible investment for almost
anyone, since you can buy savings bonds in amounts as low as $25. For
instance, you can buy a $50 Series EE bond for $25, and at maturity you can
redeem it for $50. As a result, savings bonds still make good gifts for
children planning to attend a college or technical school. That is not all.

Savings bonds have at least two more advantages. They can provide a tax
shelter; for instance, you would not pay income tax on the earnings of
Series EE bonds until you redeemed the bonds. In addition, savings bonds
are easy to acquire from a variety of resources. Besides being extremely
easy to acquire, a savings bond offers another attractive purchasing
feature: no seller’s fees. Unlike stock purchases, there are no fees or
commissions that add to the purchase price.

Where do you buy Savings bonds? Savings bonds are sometimes available
through a payroll deduction plan at work. Also you could purchase them at a
variety of government offices and financial institutions: Banks, Credit
Unions, Federal Reserve banks and branches – by phone or mail only (The
Federal Reserve no longer provides a walk-in service), and the Bureau of
Public Debt.

Anyone who bought or received a savings bond before 1980, they owned a
Series E or Series H savings bond. That year, Series EE and Series HH bonds
replaced the original series. The two current series offer a different
maturity and interest rate. In 1998, the U.S. Government introduced
inflation-indexed Series I bonds. The U.S. Government issues Series EE
bonds at one-half their face value, which ranges from $50 to $10,000. At
maturity, you can redeem the bonds at their face value. You may buy up to a
face value maximum of $30,000 in Series EE bonds annually. Series EE bonds
earn 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 E
or Series EE bonds. A minimum acquisition is $500. Other denominations
issued are $1,000, $5,000, and $10,000. Unlike Series EE bonds, you
purchase Series HH bonds at their full face value and thereafter receive
regular interest payments. Series I bonds also are sold at their full face
value, beginning with a minimum denomination of $50. Other denominations
are $75, $100, $200, $500, $1,000, $5,000, and $10,000. Like Series EE
bonds, you receive the interest earned when you cash the bond. I bonds earn
interest for 30 years.

The current rate on Series EE bonds is 2.61 percent interest, through
April 2004. New interest rates are announced twice a year and take effect
May 1 and November 1. If held for five years, Series EE bonds pay 90
percent of the six-month average yield on five-year Treasury securities.

Earnings vary for Series EE bonds issued from 1980 to 1997. Many Series E
bonds have stopped paying interest. You receive the interest earned along
with your principal when you cash in the bond. Series HH bonds pay a fixed
rate of interest from the date you purchase the bonds. In August 2004 it
will be the last issue month for HH/H bonds. After August 31, 2004, no one
will 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 earn
4.66 percent interest for the first six months. The rate is a combination
of a fixed rate of 1.1 percent (fixed for the life of the bond) plus an
adjustable rate (adjusted six months) based on inflation. You receive the
interest earned along with your principal when you cash in the bond. The
federal government developed Series I bonds to assure investors a rate of
return 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 need
the money to return to school, for a long-awaited retirement cruise, or for
a hundred and one other reasons. Generally, the easiest way to redeem
savings bonds is through a local bank, credit union, or other financial
institution, although you also can contact the U.S. Bureau of Public Debt
or the nearest Federal Reserve Bank. Redeeming savings bonds at a local
financial institution is a simple and straightforward process. If you are
not the owner of the bonds, you will also have to establish that you are
entitled to cash them. For example, you may be listed as a beneficiary on
the bonds of someone who has died and in addition can provide a death
certificate of the former bond owner. In addition, you can redeem your
bonds for their full value, unless you have held them for less than five
years. 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 two
years, you would receive interest for 21 months-not 24 months.

In the other hand, before cashing your Series EE bonds, you have the
opportunity to exchange them for Series HH bonds instead, especially if
they are near maturity. Series HH bonds will pay twice-yearly interest
payments. In addition, exchanging Series E or EE bonds for HH bonds will
continue to provide a tax shelter for the funds invested (Series I bonds
may not be exchanged for HH bonds.) In order to exchange Series E or EE
bonds, they must be at least six months old (12 months old if purchased
February 2003 and after). They also must be currently worth at least $500
and must be exchanged within one year of maturity. Since Series HH bonds
are available only in multiples of $500, you can elect to either receive
some of your Series E or EE investment in cash or pay additional funds in
order to acquire the HH bonds. For instance, if you want to exchange Series
EE bonds worth $1,200 for Series HH bonds, you can receive either $1,000 in
HH 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 to
exchange Series E or EE bonds for Series HH bonds is through a local
financial institution, which can help with the paperwork and transmit your
application to a Federal Reserve Bank. Or, you can get an application and
file it yourself with the nearest Federal Reserve branch.

While savings bonds do not earn high interest, the low interest rate
is sometimes compensated by favorable tax terms. What specifically are the
tax advantages? For starters, you do not pay any state or local taxes on
the earnings of any savings bonds you own. While you must pay federal taxes
on the earnings of Series HH bonds in the year that you receive that
interest, you can defer earnings and taxes on Series E, EE and I bonds for
long periods. Also, you can hold Series EE and I bonds for 30 years. After
that period, you can exchange Series EE bonds for HH Series bonds and then
hold them for another 20 years. After 20 years, you must redeem the HH
bonds 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 redeem
the bonds while the child is still your dependent, you will pay taxes on
the earnings at the child’s rate. The child’s rate may be 0 percent if the
child’s total unearned income is $700 or less; in any case, it is almost
certainly 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 are
redeemed to pay for qualified education expenses. To qualify for this
program, an adult age 24 or older must buy the bonds. He or she then must
redeem them and document tuition and certain other education-related
expenses. (Room, board, and books are not qualified.) If the value of the
bonds redeemed is greater than the qualified expenses, only the proportion
used for qualified expenses is tax-free. The full exclusion is also only
available to single taxpayers with annual income below $53,100 and married
persons filing jointly with income below $78,350. Single taxpayers with
income 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 giving
savings bonds each year or buying savings bonds. Besides offering several
tax advantages, savings bonds can provide a reasonable, inflation-indexed
return and a steady investment vehicle for the long term and not to mention
the safety and backing of a U.S. Government-issued security.


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