There Is More to Investing in Series EE Savings Bonds Than Meets the Eye
From a Minimum Guaranteed Rate of Return to Special Tax Benefits, Series EE Savings Bonds Are More Interesting Than They Appear
There was a time when investing in Series EE savings bonds was ubiquitous. Generations of children would receive these fixed-income holdings from a grandparent, uncle, aunt, godparent, or other family member and would have known what they were, how they work, and why the Series EE savings bonds were so special. Decades of historically low interest rates, combined with a shift in household incomes, the rise of the 401(k) and both Traditional IRA and Roth IRA, and a more-than-satisfactory return on common stocks conspired to make Series EE investments fade from the spotlight.
Yet, conditions may be changing. For the right investor, under the right circumstances, investing in Series EE savings bonds can make a lot of sense. So much so, in fact, that my goal in writing this article is to:
- Provide a brief history of savings bonds in the United States;
- Answer the question “What are Series EE savings bonds?”;
- Offer a comparison between the Series EE savings bonds and another popular alternative, Series I savings bonds;
- Detail how you can invest in Series EE savings bonds, including where to buy them and the annual purchasing limits that apply; and
- Explain some of the market and tax advantages that the Series EE savings bonds possess, especially in comparison to U.S. Treasury bills, notes, and bonds, U.S. Government agency bonds, tax-free municipal bonds, and corporate bonds.
My hope is that you will be able to use it as a reference in the future, in the event you have any questions that arise.
A Brief History of U.S. Savings Bonds as an Investment
As conflict raged across the world in the 1930s and 1940s, the federal government of the United States issued a series of savings bonds meant to accomplish two objectives: 1.) To raise funds to support defense, and, later, the waging of outright war, and 2.) to give smaller investors a mechanism through which they could save a good deal of money without having to risk it in the secondary stock or bond markets. The latter was important because the cataclysm of the Great Depression – the worst economic collapse in six hundred years – had just occurred and remained on the mind of nearly every investor in the country who might have otherwise felt more secure keeping cash stuffed in a coffee can or under a mattress.
Retired and Historical U.S. Savings Bond Series
Specifically, between 1935 and 1941, the federal government of the United States had issued several types of savings bonds. They were:
- Series A savings bonds – Issued in March 1935 and discontinued in December of that same year
- Series B savings bonds – Issued in 1936 and discontinued that same year
- Series C savings bonds – Issued in 1937 and discontinued in 1938
- Series D savings bonds – Issued in January 1939 and discontinued in April 1941
Series A – Series D savings bonds were issued in paper certificate form and could be purchased at 75% of their face value. Face value denominations were $25, $50, $100, $500, and $1,000. This meant, for example, that a $25 bond was issued at $18.75. Interest accrued on the savings bond and was paid out when the bond was cashed. Interest income on Series A – Series D savings bonds was not subject to tax. The bonds matured in ten years.
In 1941, the U.S. government issued three additional types of savings bonds. They were:
- Series E savings bonds – Issued in May 1941 and discontinued in June 1980. The Series E savings bonds were issued at 75% of face value and came in face value denominations of $25, $50, $75, $100, $200, $500, $1,000, $10,000, and $100,000. Series E savings bonds issued between May 1941 and November 1965 had a maturity period of 40 years, while Series E savings bonds issued between December 1965 and June 1980 and a maturity period of 30 years. Interest accrued throughout the life of the bond and was paid at the time the bond was cashed.
- Series F savings bonds – Issued in 1941 and discontinued in April 1952. Series F savings bonds were issued at 74% of face value and had a maturity period of 12 years. Interest accrued and was paid out when the savings bonds were cashed. Face value denominations were issued at $25, $50, $100, $500, $1,000, $5,000, and $10,000.; and
- Series G savings bonds – Issued in 1941 and discontinued in April 1952, Series G savings bonds were issued at full face value and came in denominations of $100, $500, $1,000, and $10,000. The maturity period was 12 years and interest was paid to the bondholder by the U.S. Treasury, via check, every six months until maturity.
In later years, the United States government issued three other types of savings bonds that are now discontinued. Those now-discontinued savings bond series are:
- Series H savings bonds – Issued in June 1952 and discontinued in December 1979. Series H savings bonds were issued at face value and came in denominations of $500, $1,000, $5,000, and $10,000. Bonds issued between June 1952 and January 1957 had a maturity period of 29 years, 8 months, while bonds issued between February 1957 and December 1979 had a maturity period of 30 years. Interest income was paid to the bondholder by the U.S. Treasury every six months until maturity.
- Series J savings bonds – Issued May 1952 and discontinued in April 1957. Series J savings bonds were issued at 72% of face value and were available in face value denominations of $25, $100, $500, $1,000, $5,000, $10,000, and $100,000. The maturity period was 12 years. Interest was accrued and paid when the bonds were cashed.
- Series K savings bonds – Issued in May 1952 and discontinued in April 1957. Series K savings bonds were issued at face value and were available in denominations of $500, $1,000, $5,000, $10,000, and $100,000. The maturity period was 12 years. Interest was paid to the bondholder by the U.S. Treasury every six months prior to maturity.
There was also another special type of savings bond:
- Series HH savings bonds – These special types of savings bonds were originally issued in 1980 and discontinued in August 2004. However, beginning in November 1982, Series HH bonds could not be bought directly in their own right but, rather, could only be acquired by exchanging Series E and/or Series EE savings bonds, and/or exchanging Series H bonds that had matured. Series HH savings bonds had a 20-year maturity period and were sold at face value with denominations of $500, $1,000, $5,000, and $10,000. Series HH savings bonds had a fixed-rate of interest that was locked in for the first decade, after which the interest rate was reset by the U.S. Treasury and remained fixed for the ten years that remained before maturity. Interest was paid by the U.S. Treasury to the bondholder semi-annually.
Each type of savings bond had its own special early redemption provisions governing the early redemption of bonds – i.e., cashing in the bond prior to maturity.
Modern Savings Bonds Still Being Issued: Series EE and Series I
For investors in 2023, there are really only two types of savings bonds that matter: The Series EE savings bond and the Series I savings bond.
What Are Series EE Savings Bonds?
An Overview of Some of the Basics of Investing in Series EE Savings Bonds
First issued in 1980 as a replacement to the earlier Series E savings bonds, Series EE savings bonds:
- Earn interest regularly for a 30-year maturity period (or less if you opt to cash the bond in prior to maturity).
- Interest income is compounded monthly. Every 6 months, the accrued interest is applied to the principal value of the bond, creating a new principal value that then receives interest in future periods.
- Since May 2005, newly issued Series EE savings bonds earn a fixed rate of interest that is established at the time of purchase. These bonds earn that fixed rate of interest for the first 20 years. At the start of the final 10 years of the 30-year maturity period, the U.S. Treasury may adjust the rate of interest, or the mechanism through which interest is earned. The rules for Series EE bonds issued prior to May 2005 vary depending upon the issue date, generally falling into four classes:
- May 2005 and later
- May 1997 through April 2005
- May 1995 through April 1997; and
- Prior to May 1995
- Series EE savings bonds issued between part of 2001 and 2011, when such bonds were issued in paper, have the words “Patriot Bond” on them. They were otherwise identical to Series EE bonds but used to fund anti-terrorism operations of the U.S. government.
- Owners of Series EE savings bonds cannot redeem the bond for the first 12 months. However, after 12 months, they can redeem it. If the bond is redeemed prior to the 5-year mark, a penalty equal to 3 months’ of interest income will be deducted from the net proceeds paid to the investor. The example the U.S. Treasury provides is that, if after 18 months, a Series EE savings bond is redeemed, the investor will receive only 15 months’ interest income (18 months – 3 month penalty due to redemption prior to five years = 15 months).
- A given Social Security Number can only purchase up to $10,000 in Series EE savings bonds each year. For jointly held Series EE savings bonds, this limit applies to the first Social Security Number recorded on the ownership record. For example, a married couple could spend $20,000 on Series EE savings bonds each year provided that $10,000 were held jointly with one spouse recorded as the first listed owner and $10,000 were held jointly with the other spouse recorded as the first listed owner. In addition, partnerships, companies, and other entities are subject to a similar purchase limit. For example, if you own a business with its own EIN or TIN, the business can also invest $10,000 per annum in Series EE savings bonds.
How Can I Invest in Series EE Savings Bonds?
Series EE savings bonds used to be issued in paper format with denominations of $50, $75, $100, $200, $500, $1,000, $5,000, and $10,000. During that period, bonds were issued at 50% of face value (e.g., if you bought a $50 Series EE savings bond, you paid $25 at the time of purchase). This is no longer the case. Since 2012, investors have not been allowed to buy Series EE savings bonds in paper format.
Instead, these days you must purchase Series EE savings bonds directly from the U.S. Treasury in electronic format. To begin, you must open an account at TreasuryDirect.gov. This account can then be used to electronically submit a purchase of Series EE savings bonds in any amount ranging from a $25 minimum up to $10,000 per annum, in penny increments. The Series EE bond is issued at full face value – e.g., if you submit a purchase for Series EE bonds in the amount of $520.88, you will pay $520.88.
The Four Main Advantages of Series EE Savings Bonds
Generally speaking, Series EE bonds can be thought of as having four main advantages, which we will discuss in turn. These advantages make them fundamentally different than the typical fixed-income investment you might find in the secondary market.
- They are backed by the full faith and credit of the U.S. government, the wealthiest and most powerful sovereign nation in world history.
- They enjoy three significant tax benefits:
- They are exempt from state income tax
- At the Federal level, the investor can defer the income tax owed until redemption or maturity providing a significant time value of money advantage; and
- Under certain circumstances, accrued interest income can be exempted from Federal taxation entirely.
- They are “non-marketable” bonds, meaning you cannot buy or sell them in the secondary market. Combined with the ability to demand redemption after 12 months, this creates a situation in which even in a rising interest rate environment, the bond cannot lose nominal value.
- The U.S. government guarantees the bonds will double in value within 20 years even if they have to make top-off payments, essentially creating a rate of return that may be higher than the fixed rate of return advertised at the time of purchase.
How Do Taxes on Series EE Savings Bonds Work?
As a fiduciary investment advisor, Kennon-Green & Co. cannot offer tax or legal advice. That said, in general academic terms, Series EE savings bonds have some profound tax advantages that any owner should discuss with his or her CPA.
Elective Deferral of Taxation of Series EE Savings Bond Interest Income
Ordinarily, bonds that receive interest income that is “accrued” – that is, earned but not actually paid out in the form of a cash deposit throughout the year – must still pay income taxes on the so-called “phantom income”. In some cases, this can result in a cash crunch for investors if the amounts involved are sufficiently large. Series EE savings bonds follow the same rules except the owner has one special power: When initially filing the taxes on a new Series EE savings bond, the owner can opt to defer the interest accrued on the Series EE savings bond until redemption or they mature at the end of 30 years.
This is extraordinarily beneficial because it means, on a time value of money basis, that the investor is able to keep more capital working for himself or herself.
If You Use Series EE Savings Bonds to Pay for Higher Education Expenses, You May Exempt Some or All of the Accrued Interest Income from Tax
Going further, for Series EE and Series I savings bonds issued after 1989, it is possible to get the accrued interest that has accumulated on your savings bond exempted from taxation entirely provided certain conditions are met.
- The Series EE savings bonds must be issued in your name or, if you are married, they may be issued in both your name and your spouse’s name.
- You were 24 years old, or older, before the bonds were issued.
- Your modified adjusted gross income is below a threshold established by the IRS in the year in which you wish to take the interest income exclusion.
- You redeem the qualifying savings bonds in the same tax year for which you are claiming the interest income exclusion.
- The expenses were for yourself, your spouse, or someone whom you listed as a dependent on your Federal income tax return.
- You paid qualified higher education expenses to an eligible institution that same tax year. The instructions found on IRS Form 8815 define both “qualified expenses” and “eligible institution”, as well as informing you as to which records you must keep.
- You file your Federal tax return with the IRS with any status except married filing separately.
Investors meeting all of the above conditions can file IRS Form 8815 to claim the tax exclusion on Series EE savings bonds.
Series EE Savings Bonds Are Guaranteed by the U.S. Government to Double in Value within 20 Years Regardless of the Fixed Interest Rate, Meaning the Actual Return Is Far Higher Than the Base Interest Rate for Long-Term Investors
The interest rate on Series EE savings bonds, at least for the next 20 years, is 2.10% provided the bond was issued between November 1st, 2022 and April 30th, 2023. However, because the Series EE savings bond is guaranteed by the U.S. Government to double in value in 20 years, we can do a quick time value of money calculation and determine that, if an investor holds his or her Series EE savings bond for the entirety of that period, he or she will actually receive a compound annual growth rate of 3.53%. That is more than 68% higher than the sticker rate. Combined with aforementioned tax benefits, this dramatically changes the risk-return calculation making them far more attractive than they might otherwise appear. The differential was far more dramatic only a few months ago when the fixed rate set for the first twenty years was a mere 0.10%.
The key thing to remember is that you do not get this guaranteed minimum return for holding less than the full twenty years. If you buy a bond between November 1st, 2022 and April 30th, 2023 yielding a fixed 2.10%, and you sell in year 18, you only get the 2.10%. There is no sort of partial or pro-rata recognition for shorter holding periods.
Series EE Savings Bonds Are Fundamentally Different Than Series I Savings Bonds
Along with Series EE savings bonds, Series I savings bonds are still being issued regularly by the U.S. Government. The Series I savings bonds are profoundly different – they have a 30-year maturity period, and the return consists of a fixed rate plus an inflation adjustment. The annual purchase limit of $10,000 for Series EE savings bonds is in addition to the annual purchase limit of $10,000 for Series I savings bonds. Furthermore, you can invest $5,000 extra, on top of the $10,000 limit, in Series I bonds by overpaying your Federal taxes and requesting your refund in the form of Series I savings bond. Note that Series I savings bonds which are acquired as part of a tax refund are still issued in paper format, with denominations of $50, $100, $200, $500, and $1,000, making them the exception to the rule.
This means, for all intents and purposes, an individual person could acquire $10,000 in Series EE savings bonds, and another $15,000 in Series I savings bonds, in a given year under their own Social Security Number.
1.) Timeline of U.S. Savings Bonds – https://www.treasurydirect.gov/research-center/history-of-savings-bond/timeline/, accessed at 10:44 a.m. Pacific Time on 01/08/2023
2.) History and retired bonds – Older Savings Bonds and Savings Securities – https://www.treasurydirect.gov/savings-bonds/historical-retired-bonds/, accessed at 10:50 a.m. Pacific Time on 01/08/2023
3.) Using bonds for higher education – https://www.treasurydirect.gov/savings-bonds/tax-information-ee-i-bonds/using-bonds-for-higher-education/, accessed at 2:51 p.m. Pacific Time on 01/08/2023
4.) Using Your Income Tax Refund to Save by Buying U.S. Savings Bonds – https://www.irs.gov/refunds/using-your-income-tax-refund-to-save-by-buying-us-savings-bonds, accessed at 7:40 p.m. Pacific Time on 01/08/2023