How to Give Bonds as a Gift

If you are wracking your brain trying to figure out what to get your loved ones as a holiday or other type of gift, consider adding bonds to your shortlist. These investments aren’t particularly flashy, so don’t expect such a gift to be met with extreme initial excitement, even if it's the best savings bonds available. Hugs and high-fives are usually spurred by instant gratification, not a piece of paper that could be potentially worth something more over the years.

Still, that’s not to say that giving a bond as a gift is a bad idea. These investments can provide the start of a nice nest egg for the recipient’s future as well as offer a useful lesson in saving and managing money.

The best gifts often are those that may appreciate well into the future. Based on that logic, you can’t really go wrong with buying your loved ones a potentially lucrative bond investment.

What Are Bonds?

When you take out a loan, you are expected to pay interest to the lender and eventually pay back the money, or principal. Bonds work in the same way—only this time, you, the investor, become the lender.

There are several different categories of bonds, with each type named after the entity to which the money is being lent. In other words, a government bond involves lending money to a government entity, while a corporate bond essentially involves lending money to corporations.

Which Bond Should I Buy as a Gift?

When you lend money to a government, company, or another entity, the amount of interest that you are paid as compensation for your investment usually depends on the health of the borrower. As a general rule of thumb, the higher the risk that the borrower may default on the loan and may be unable to pay it back, the greater the interest rate payment you’ll receive for the additional risk.

Many U.S.-based gift givers will find that savings bonds check most of their desired boxes. These securities essentially offer citizens the opportunity to lend money to the U.S. government to help fund federal spending. In exchange, the people putting up the capital are rewarded with interest payments until the loan is eventually repaid.

The beauty of savings bonds is that because they are backed by the U.S. Treasury, they are guaranteed by the full faith and credit of the U.S. government. They’re also really easy to gift and can be affordable. With corporate bonds, you typically need to cough up at least $1,000 for a minimum purchase. Savings bonds, on the other hand, can be bought for as little as $25.

Types of Savings Bonds 

There are two common types of savings bonds: Series EE Bonds and Series I Bonds. Both are sold at face value, have an annual purchase limit of $10,000, and pay interest, which accrues monthly and is compounded semiannually, until the 30th year. The key distinctions that separate the two are the rate of interest that they pay out and also that Series I Bonds can be purchased in paper format with an Internal Revenue Service (IRS) tax refund.

Before deciding which savings bond to opt for as a gift, it would be wise to consider the outlook for interest rates and inflation, as well as how long you expect the recipient to hold it. If the gift isn’t going to be cashed in for at least 20 years, and if inflation and interest rates are likely to fall in that period, then the Series EE Bond probably makes more sense. Conversely, the prospect of rising living costs, rate hikes, and an earlier withdrawal would make the Series I Bond a better option.

Series EE Bonds

Series EE Bonds issued after May 2005 pay a fixed interest rate that’s determined at the time of purchase and guaranteed for the first 20 years, making them ideal when rates are higher than normal and likely to fall. They also come with a promise of doubling in value if kept for 20 years.

Series I Bonds

Series I Bonds (aka TIPS, or Treasury Inflation-Protected Securities) don’t make such promises but instead deliver another benefit: protection against inflation. These bonds provide a semiannually adjustable variable rate on top of a fixed rate, giving the owner peace of mind that they won’t erode in value due to inflation.

Where and How Can I Buy Savings Bonds?

The main place that you can buy savings bonds is through the U.S. government site TreasuryDirect. The government sells bonds directly to people through this site.

EE Bonds are only available for purchase through TreasuryDirect. You can no longer purchase paper EE Bonds. I Bonds are available as both electronic and paper bonds, but you can only purchase I Bonds using any money the IRS owes you when you file your tax return and the annual limit on paper I Bonds is lower than the annual limit on electronic I Bonds.

How to Keep Track of Your Savings Bond Over Time

If you have electronic bonds in your TreasuryDirect account, you can check the balance and current interest rate of the bond by signing into your account. You'll also be able to view information such as the final maturity date and the next date on which interest will accrue.

If you have paper bonds, TreasuryDirect has a calculator that you can use to check its value and other details. By entering the bond series, denomination, serial number, and issue date, the calculator can provide you the bond's value from January 1996 to the present.

Value of a Savings Bond Over Time

Over time, savings bonds gain value due to the interest that the government pays. Both EE and I bonds earn interest monthly, with interest compounding semiannually. That means that twice each year, the bond's principal value increases and the added interest will start earning interest.

Series EE Bonds offer a unique feature where they are guaranteed to double in value when held for twenty years. If the bond doubles in value in fewer than twenty years, this feature has no effect. This means that if you hold an EE Bond for twenty years, it will offer a return equivalent to it having a 3.496% interest rate at worst.

Determining the value of an EE Bond over time is relatively easy given its fixed rate and automatic doubling after twenty years. Using a compound interest calculator can let you determine its future value. Finding the value of an I Bond in the future is more difficult because its interest rate will adjust every six months based on inflation.

Maximizing Your Savings Bond Returns

Maximizng your return on savings bonds requires a few different things.

First is timing the purchase of your bonds properly. EE Bonds offer a fixed interest rate and a portion of the interest paid by I Bonds is also fixed. Buying bonds when rates are high will offer greater returns than buying bonds when their returns are low.

For EE Bonds in particular, holding them for at least twenty years ensures they will double in value. Ensuring you hold them for a long enough period will increase your potential returns.

Finally, you need to avoid penalties. With both EE and I Bonds, you must hold the bond for at least twelve months before cashing it in. However, if you cash in a bond within five years of buying it, you'll pay a penalty equal to three months' interest. Holding a bond for at least five years will let you avoid this penalty.

Yearly Cap on Savings Bonds

There are limits on buying savings bonds. Each year, you can purchase a total of:

• $10,000 in electronic EE bonds
• $10,000 in electronic I bonds
• $5,000 in paper I bonds that you can only buy when you file federal tax forms, with your tax refund.

It's important to note that these limits apply per Social Security number. That means that you and a spouse can buy up to these limits each, even if you file joint tax returns. It also means that bonds that are given as a gift count toward the limit of the recipient rather than the person giving the bond.

If you have reached your annual savings bond limit, you might consider having your spouse purchase bonds or buying gift bonds for a dependent or friend.

Can’t Decide Which Bond to Buy? Consider ETFs

If government savings bonds aren’t your style, bond exchange-traded funds (ETFs) are a great way to gift multiple bonds in one transaction. Broad-based bond ETFs typically contain a mix of government, agency, corporate, and municipal debt issues. You can choose index-based ETFs (which usually have the Standard & Poor’s 500 or the Bloomberg Aggregate ETF Tracker as their benchmarks) such as BND, AGG, and BNDX (includes foreign bonds), among many others. Or you can opt for more specific types of bonds, such as bank loans, or Chinese-issued bonds. Most bond ETFs only hold investment-grade bonds (>BBB), to be attractive to conservative-minded investors.

There is virtually an ETF for most any country or duration, or holding period, which should make your decision a lot easier. You can search the web for the specific bond (or fixed-income) ETF that covers the sector, region, or index to which you’re attracted, and you’re likely to get many selections back from which to choose. Also, to make ETFs even more attractive, they function like regular shares and can be bought and sold on a fractional basis.

Fractional Shares

If buying a corporate bond ($1,000 face value) is beyond your gifting budget, a bond ETF may be the answer you’re looking for. As with most other securities today, you can buy a fractional amount, or dollar-based amount, that fits your gift-giving generosity.

In this case, you’re interested in gifting a corporate bond to your recipient. For example, let’s say BND is trading at $71.30, but you’re only thinking of gifting $50 for your present. With fractional shares, you can buy exactly $50 of BND for your gift and thereby stick to your gift-giving budget.

How to Gift Savings Bonds

Savings bonds can be purchased from the U.S. Treasury Department, banks, and credit unions. Often, the simplest way to buy them as a gift is through the TreasuryDirect website. The process is fairly straightforward, and there are plenty of useful guides and tutorials available on the site to help guide you through it.

In short, you’ll need to take the following steps:

1. Enter the TreasuryDirect website.
2. Create a TreasuryDirect account and then log in.
3. Purchase the savings bond you want in the desired denomination ($25 to $10,000).
4. After the mandatory five-business-day holding period ends, deliver the gift to the recipient’s TreasuryDirect account. To do this, you’ll need to know the recipient’s account number and legal name, as well as their Social Security number. For children under age 18, a minor linked account can be created by a parent or guardian.
5. Print out a gift certificate and give it to the chosen recipient.

How to Cash in a Savings Bond

Once the savings bond has been gifted, the recipient can withdraw the proceeds at any point after 12 months. However, it’s generally advisable to leave the bond alone for at least five years—or 20 years, in the case of the Series EE version.

Actually cashing in is simple. All the recipient needs to do is log in to their TreasuryDirect account and follow the instructions to redeem the bond. Once this task has been completed satisfactorily, the cash value should be credited to the designated bank account within two business days.

Before collecting the proceeds from their gift, the recipient should check what the bond is worth. For paper bonds, this can be achieved by logging in to your account and using the TreasuryDirect savings bond calculator. Remember, most savings bonds stop earning interest after 30 years, and those sold within five years are subject to a penalty—if the recipient sells before then, they’ll lose three months’ worth of interest.

Gifted Bond Tax Considerations

U.S. government bonds, unlike corporate bonds, are not subject to state income tax. The owner of a savings bond is only taxed at the federal level, and because interest payments are not distributed until the investment matures or is redeemed, paying any taxes on them is not necessary until later.

Most people will take advantage of this option and defer reporting interest on these bonds until they actually receive the money. In this case, they would declare the total amount that they received from their investment on their federal income tax return in the year when it matured or was sold.

The option of reporting interest accrued every year to the IRS shouldn’t always be completely written off, though. For example, this might make sense if the savings bond is registered in a child’s name. The logic here is that the child will likely be earning little to no income and thus be in a lower tax bracket than they presumably will be in later years, when the bond matures.

It’s also worth bearing in mind that interest from U.S. savings bonds may be excluded from federal income tax if the proceeds are used to pay higher education expenses.

The Bottom Line

Rather than a gift of stock, which could drop in value over time, gift-givers may want to look at giving bonds as a financial present. Highly rated bonds (>BBB) represent a lower-risk investment and are most likely to meet all of their financial obligations, such as paying interest and paying back the principal. The gift of a bond is also a great way to get the recipient more involved in savings and investing by teaching lifelong money management skills.

Government savings bonds (EE and I) are among the simplest and most convenient ways to give a bond investment. Investors can transact saving bonds easily through the U.S. government’s TreasuryDirect website, where various savings bonds can be purchased. Alternatively, you can seek out an appropriate bond ETF and purchase it on a fractional basis, or for a fixed U.S. dollar amount.