I bonds and EE bonds

In short

A friend of mine once kept a shoebox of paper savings bonds in his closet and forgot about them for years. If you are holding money you will not need soon, an I bond or an EE bond may be worth a look. Both are loans you make to the United States government, and you buy them at TreasuryDirect, the Treasury's own website. An I bond pays a rate with two parts, a fixed piece and a piece that moves with inflation. An EE bond pays a fixed rate, and the Treasury's own rule is that an EE bond is worth double its price at twenty years. Neither one can be cashed in during the first twelve months. Cash in before five years, and the penalty is three months of interest. The yearly purchase cap is the current figure, which the official source publishes each year per person for electronic I bonds, and the current rates are on the TreasuryDirect page.

The whole of it

What it is

I once watched a neighbor lend a tool to a man down the road and get it back, sharpened, a month later. That is about how a savings bond works, only the borrower is Washington and the thing lent is your cash. You hand the Treasury some money, the Treasury pays you interest for the use of it, and your money comes back when you ask, as long as you have waited long enough.

There are two kinds worth knowing. The I bond is built to keep up with rising prices. The EE bond is built to be simple and sure. Both are sold in electronic form at TreasuryDirect. Both earn interest every month, and that interest is added to the bond's value twice a year. Neither one can lose face value. That is a real comfort. I do not mean to wave it off.

If you like your savings quiet and safe, these bonds were made with you in mind. They will not make you rich. They are a place to park money so it holds its own. That is plenty.

How it works

You have probably wondered why anyone would tie up money for a few extra points of interest. Let me tell you how the two bonds differ, and you can judge for yourself.

An I bond has a composite rate. That is a plain name for two rates added together. The first is a fixed rate, and it stays the same for the whole life of that bond. The second is an inflation rate, and the Treasury resets it twice a year, every May and November. When prices climb, that piece climbs too. When prices fall, it can drop, though the composite rate can never go below zero. An I bond earns interest for up to thirty years.

An EE bond works more simply. It has one fixed rate, set when the bond is bought. The Treasury's rule is that the bond is worth double the price paid once twenty years pass. If the fixed rate alone would not reach that mark, the Treasury makes up the gap with a one time adjustment at year twenty. Doubling in twenty years works out to about 3.5 percent a year. An EE bond keeps earning for thirty years in all.

Now the rules on cashing out. The holder must wait twelve months before redeeming either bond. Cash in before the five year mark, and the Treasury takes the last three months of interest. After five years, no penalty applies. That is the whole cost of leaving early, and it is small.

Taxes are friendlier here than on many savings. The interest is subject to federal income tax but not to state or local income tax. The owner can pay the federal tax each year as interest builds, or wait and pay when the bond is cashed in or stops earning, whichever comes first. Some families who pay for college can leave the interest out of income, under rules that carry income limits. The IRS explains them in Form 8815 and its instructions.

The numbers, and where to find yours

A neighbor of mine used to say you cannot plan a trip without a map. The figures below are your map. They change, so I leave the live ones to the official pages.

The yearly purchase cap for electronic I bonds is the current figure, which the official source publishes each year per person. The current I bond fixed rate is the current figure, which the official source publishes each year. The current I bond inflation rate for the six month period is the current figure, which the official source publishes each year, and the composite rate that results is the current figure, which the official source publishes each year. The current EE bond fixed rate is the current figure, which the official source publishes each year. The waiting period before cashing in is twelve months. The early cash in penalty is three months of interest before year five.

Where do you find your own? Go to the TreasuryDirect website and look for the page on current savings bond rates. The Treasury posts the new I bond rate each May and November. A bond's fixed rate depends on the month it was bought. Open your own account, then read the line for each bond you hold.

A worked example

Let me tell you about a woman I will call Margaret. She is a schoolteacher, 41 years old, and she sets aside $5,000 for a roof she expects to replace in about six years. She does not want her roof money jumping around, so she looks at an EE bond.

Say the fixed rate on her EE bond is 2.5 percent. Here is the twenty year check. At 2.5 percent, $5,000 grows to about $8,193 in twenty years. That falls short of $5,000 times 2, which is $10,000. So the Treasury's rule applies, and a one time adjustment lifts her bond to $10,000 at year twenty. Margaret will not wait that long. She will cash in at year six.

At year six she is past the five year mark, so no penalty applies. Her bond has grown by 2.5 percent a year, with interest added every six months. Her $5,000 reaches roughly $5,800 by then. That is about $800 of interest. If she pays federal tax on it at 22 percent, the tax is $800 times 0.22, which is $176. Her interest after tax is $624. Her roof fund comes to $5,624, give or take a few dollars.

Had Margaret needed the money at month nine, she could not have touched it. Had she needed it at month thirty, she would have lost three months of interest. At 2.5 percent, those three months cost about $5,200 times 0.025 times 0.25, which is roughly $33. That is a small price. It is good to know before you start.

Where it goes wrong

I have made my share of mistakes with money, and most began with skipping the fine print. A few traps are worth naming gently.

The first is needing the cash too soon. Money in a bond is locked for twelve months, no matter what. If an emergency could hit before then, keep that money somewhere within reach.

The second is forgetting old paper bonds. They can sit in a drawer long past the day they stop earning. The Treasury can help an owner find lost or unclaimed bonds, and the TreasuryDirect site has a tool for that.

The third is chasing a rate. The I bond inflation piece changes every six months, so the rate you see today is not the rate you will earn next year. A person can feel let down when the number drops. Knowing it can move keeps the surprise small.

The fourth is the cap. The yearly purchase limit applies per person, and a tax refund can be used to buy bonds through IRS Form 8888. Read the limit on the official page rather than trusting a figure from memory.

The last is the tax. The interest is not tax free at the federal level. Keep your records, and filing time will hold no surprises.

Questions to answer before you leave this page

When will you need this money, and is that date more than twelve months away? Could you leave it alone for five years and skip the three month penalty? Do you want a rate that follows inflation, or one that stays put? Have you checked the current I bond and EE bond rates at TreasuryDirect, and do they suit what you hope to earn? Do you know how much you can buy this year under the yearly cap? Will you pay the federal tax on the interest each year, or at the end? Are there old paper bonds in a drawer that deserve a second look? And have you set up a TreasuryDirect account, and kept the login where you will not lose it?