6. Nonmarketable Securities: Savings Bonds
The U.S. Treasury also sells savings bonds. Unlike T-bills, T-notes, and T-bonds, savings bonds aren’t marketable, which means they can’t be bought and sold after they’re issued. Only the person whose name is on the bond has the right to cash it. But you can buy savings bonds for other people by putting their name on the bond rather than your own.
In addition, the rules for purchasing savings bonds are somewhat different from those for buying Treasuries. To begin with, only U.S. residents, U.S. citizens living outside the country, and employees of the U.S. government can own savings bonds. That’s not the case with Treasury securities, which may be purchased regardless of your citizenship, residency, or employment. Savings bonds can also be owned directly by children under 18, whereas minors generally can’t own securities directly.
If you’re a parent, you might consider using savings bonds as one part of your college savings plan. If your income is less than a specific level that Congress has set at the time you cash in the bond, the earnings are free of federal tax if you use the money to pay qualified college expenses. One thing to remember if you’re considering this strategy is that you, as the parent, must be the owner of the bonds to receive this tax break. Your child can’t be listed as the owner.
Types of Savings Bonds
There are two main types of savings bonds currently sold by the Treasury: EE savings bonds and I savings bonds, which have many common features:
- They accrue monthly interest until they’re cashed.
- Interest compounds semiannually.
- They can be cashed in after 12 months.
- Bond owners forfeit 3 months of interest if they cash in the bonds within five years of purchase.
- Interest is free of state and local taxes.
- Earnings are free of federal tax if you are eligible to use them to pay qualified education expenses.
- A maximum of $5,000 of each type of savings bond may be purchased per Social Security number or tax identification number each calendar year.
Savings bonds are sold electronically through TreasuryDirect at face value in any amount $25 and over. You can also buy paper savings bonds through financial institutions like banks, but not through TreasuryDirect.
Some employers also offer purchase programs that let you buy paper savings bonds. The paper certificates come only in a limited number of denominations: $50, $75, $100, $200, $500, $1,000, $5,000, and for Series EE bonds only, $10,000. While Series I savings bonds are purchased at their face value (for example, a $1,000 I bond costs $1,000), Series EE paper bonds are purchased at 50% of their face value. In other words, a $10,000 EE bond costs $5,000, and accrued interest makes up the difference when you redeem. Once you have a paper savings bond, however, you can trade it in for an electronic savings bond through TreasuryDirect, which can make the bonds much easier to track and manage.Series I savings bonds differ from the EE variety because their interest rates are partly indexed to inflation. EE savings bonds pay a fixed rate of interest for up to 30 years and are guaranteed to double in value in 20 years due to accrued interest. (Note: The interest rate on EE savings bonds sold before May 2005 is variable and resets twice a year.) Series I savings bonds, on the other hand, actually pay a combination of two rates: a fixed rate, which stays the same as long as you hold the savings bond, and an inflation-adjusted rate, which is set every six months according to changes in the Consumer Price Index.
Starting in 2010, you can buy I bonds by checking a box on your tax return. The federal government is amending IRS Form 8888 to allow taxpayers to direct all or part of their refund to the purchase of I bonds, which will be issued as paper bonds and mailed to the taxpayer. For more information, visit the IRS’s Web site at www.irs.gov.
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