US Savings Bonds and Certificates of Deposit (CD): What’s the difference?

Both US savings bonds and certificates of deposit (CD) are savings instruments that provide moderate profits to ensure a high degree of security. In both cases, investors lend some cash in exchange for paying a certain amount of interest. Both are simple and convenient investment methods, without the need to go through a broker. Your savings will be safe and earn interest.

However, there are differences, and the biggest one comes down to time. US savings bonds are intended to be a long-term investment, while CDs have a maturity as short as one month.

Key points

  • If you are making long-term investments, U.S. savings bonds are a good choice.
  • Series I savings bonds have variable interest rates, which can bring the benefits of future interest rate hikes to investors.
  • If you are saving short-term, CD offers more flexibility than savings bonds.

U.S. Savings Bonds

The value of US savings bonds is guaranteed to double within 20 years. If held for up to 30 years, it can continue to earn interest. This is why savings bonds are traditional gifts for newborn babies.

Savings bonds cannot be cashed in the first year, and if they are cashed in less than five years, they shall be fined three months. After that, the owner of the bond will recoup the purchase price in full and give up future interest payments.

There are two main types of U.S. government savings bonds:

  • The series of EE savings bonds pay fixed interest, guaranteeing to double the value of the bonds within 20 years. Interest rates are fixed when bonds are purchased, and taxes are postponed until the bonds are redeemed. By October 2021, the interest rate of EE bonds will be fixed at 0.10%.
  • Series I savings bonds have fixed and variable interest rates. The fixed interest rate is set when the bond is purchased, and the floating interest rate is adjusted every six months based on consumer price inflation. If interest rates soar over the duration of the bond, this can prevent investors from regretting it. By October 2021, the interest rate of I bonds will be fixed at 3.54%.

Certificate of Deposit (CD)

CDs are issued by banks and are a type of savings account. They pay a little more interest than ordinary savings accounts. The purchase period of CDs is as short as one month and as long as 10 years. The shorter the term, the lower the interest rate.

The interest rate offered at any given time is linked to the current preferential interest rate. Therefore, if you buy CDs during periods of low interest rates and low inflation, it makes sense to avoid long-term capital occupation. If it looks like interest rates will rise soon, you can buy a 1-month, 3-month, or 6-month CD and shop around when it expires for a more cost-effective deal.

Some investors use a strategy called ladder to invest in CDs. Regardless of the interest rate offered, they buy a new CD every month or every three months. This allows them to get the highest interest rate at any given time, while ensuring that as the old CD matures, they can get some cash at any time.

Of these two investment options, CD is more flexible. You do not have to commit to long-term investment or long-term occupation of funds. However, if you need to redeem the CD in advance, you will be fined. It is also not a good idea to keep your emergency fund in a CD, because early withdrawal of fines may consume months of interest or even a small amount of principal.

It is worthwhile to shop around and buy a CD, because every bank sets interest rates based on the current prime rate.

special attention items

Both savings bonds and CDs are considered extremely safe investments. The U.S. savings bonds are rated AAA and “received the full trust and credit support of the U.S. government.”CDs up to $250,000 are fully insured by the Federal Deposit Insurance Corporation (FDIC).

Income from CDs is taxable at the state and federal levels. In addition, these gains are taxed as interest income rather than as capital gains, which have a lower tax rate. You should receive a 1099-INT form from the financial institution holding the CD.When your income spans multiple tax years, you only need to pay taxes for that tax year’s income. If you hold a CD in a tax-friendly retirement account (such as a 401(k) or an individual retirement account (IRA)), these taxes can be deferred.

Any interest earned from savings bonds is taxable. You need to report this interest income in your annual federal tax return. However, state and local taxes are not assessed.

In addition, if you use them to pay for qualified higher education expenses and you are a qualified taxpayer, Series EE and Series I bonds may be eligible for education tax exemption.These funds can help you offset tuition and other expenses.

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