What it is:
How it works/Example:
EE Bonds are zero-coupon bonds in that they earn interest monthly but do not pay that interest until they mature or are redeemed. The interest compounds semiannually.
EE bonds come in either paper or electronic form. Paper EE bonds are sold at 50% of face value, meaning that the investor pays $50 for a $100 bond, and the bond is not worth its face value until it matures. Electronic EE Bonds, on the other hand, are sold at face value, meaning the investor pays $50 for a $50 bond.
Electronic EE Bonds can be purchased in any amount over $25, but paper savings bonds can only be purchased in $50, $75, $100, $200, $500, $1,000, $5,000, and $10,000 increments. Investors can purchase up to $30,000 worth of EE Bonds in one year from a financial institution or via the U.S. Treasury's TreasuryDirect website.
[InvestingAnswers Feature: How to Use TreasuryDirect to Buy U.S. Government Bonds]
Note that U.S. citizens, official U.S. residents and U.S. government employees (regardless of their citizenship status) can buy and own EE Bonds. Minors can also own EE Bonds.
When an EE Bond matures, the investor receives the face value of the bond plus accrued interest. EE Bonds are not redeemable for the first 12 months they're outstanding, and investors who redeem them within the first five years forfeit the last three months of interest as a penalty. It is important to note that although an EE Bond continues to earn interest until the final maturity date, the final maturity date can be many years after the original issue date.
Today's EE Bonds typically earn interest for 30 years, but older EE Bonds have different maturities and interest rates. For example, EE Bonds issued before November 1982 earn interest at the higher of a guaranteed or a market-based rate. Bonds issued between November 1982 and February 1983 offered a guaranteed rate for an initial number of years and then carried a variable market-based rate thereafter. Bonds issued from March 1993 to April 1995 only have 18-year maturities, while bonds issued from May 1995 to April 1997 have 30-year maturities.
EE Bonds issued after May 2005 carry a fixed interest rate equal to 90% of the average market yield on five-year Treasuries during the six months before the EE Bond's issue. The Bureau of Public Debt rate on May 1 and November 1.
Interest from EE Bonds is exempt from state and local taxes. It is subject to federal tax, however, but only in the year in which the bond matures or is redeemed.
Why it matters:
EE savings bonds are simple and low-risk investments. The state and local tax exemption, as well as a federal exemption for tuition payment, make EE bonds especially advantageous for investors in high tax brackets or those with children heading to college.
EE bonds are very liquid -- they can be redeemed online or at nearly any financial institution (but note that they have no secondary market, meaning that they cannot be traded among individual investors).
However, EE Bonds offer a very low rate of return and lack protection from inflation due to their fixed interest rate. There is also no capital gains opportunity with EE bonds, nor do they provide current income unless the investor redeems the bond. Because EE bonds already offer a tax deferral, it is rarely advantageous to hold them in tax-deferred accounts.