Tax Saving Bonds
Series E and EE savings bonds are also state and local tax free, except that the interest on them may be deferred until maturity. Series H and HH bonds pay taxable interest semiannually until maturity. Series I bonds also pay taxable interest, which may be deferred like Series E/EE bonds. The interest from Series E and I bonds may also be excluded from income if the proceeds are used to pay higher education expenses.
Despite the fact that they have no stated coupon rate, zero-coupon investors must report a prorated portion of interest each year as income, even though it has not been paid out. Zeros are issued at a discount and mature at par, and the amount of the spread is divided equally among the number of years to maturity and taxed as interest, just as any other original issue discount bond.
There are four main benefits of purchasing savings bonds
Competitive Interest Rates
The U.S. government offers interest rates that are often competitive with the market. Some bonds are adjusted for inflation while others are offered at a discount on an accrual basis, guaranteeing redemption of face value after 17 years. In addition to this, all bond interest payments are compounded semi-annually and accrued monthly so that your investment grows faster.
This monthly interest accrual is something that is not usually found in most other bonds. For example, in a corporate bond, you receive your interest payment every six months. In the Series EE and Series I savings bonds, the interest is calculated monthly and then reinvested rather than paid out. For calculation purposes, the government will use the value of the bond on the date that compounding is to take place to calculate the interest payment.
Because the U.S. government issues savings bonds in the hope of attracting more people, they sweeten the deal with added deferred and exempted tax benefits. All of the interest income earned on these bonds is completely exempt from state and local income taxes and postponed from federal taxes until redemption or maturity.
This can be an important issue for many investors, especially those in the higher federal tax brackets or those living in regions with high local and state taxes. Additionally, the interest may be exempt from federal income taxes if the bond is used to pay for the bondholder's educational expenses.
Savings bonds also provide a convenience not readily found in other fixed income products. They are issued in eight different denominations starting at $50 and moving progressively up to $10,000. This produces flexibility for investors looking to invest sums of money in increments less than $1,000. Furthermore, these bonds can be redeemed at any time after the initial minimum holding period of six months. Keep in mind that if you do redeem early (before the five-year holding period), your principal will never decrease, although you will be charged a penalty equal to the last three months of interest payments.
Even though these bonds are not marketable, like a stock or corporate bond, purchasing and redeeming savings bonds is relatively straightforward. You can buy these bonds at any bank, or, by using major credit cards, you can even buy savings bonds online at the Bureau of Public Debt's website. Some companies even offer internal monthly purchase plans that deduct employee paychecks. Redeeming them is even simpler, as most banks will redeem the bonds with proper identification, even if you don't hold an account with them.