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How Treasury Bonds Work

January 10, 2012

The term “treasury bonds” refers to a number of different securities issued by the US Treasury Department. The Treasury issues a variety of securities in order to fund government activities. Uncle Sam issues these notes because the amount of taxes the federal government collects is lower than government spending. This is the national debt or deficit that you are constantly hearing about on the news.

Treasury-backed securities are considered a good investment because the government can collect more taxes or print more money to pay them. More importantly the United States government has never defaulted on its obligations. That is why Treasury securities are usually given the highest rating. It is also why most investment experts recommend that everybody keep at least part of his or her money in Treasury securities.

Types of Treasury Bonds

The Treasury actually issues a number of different debt instruments that anybody who has the money can invest in. The most popular offerings include:

Treasury notes are securities with maturation periods ranging from 2 to 10 years. Maturation means the bond has to be cashed in at that time. These instruments pay interest every six months.

Standard Treasury Bonds mature in 30 years and pay interest every six months. The I Savings Bonds are a low risk savings product that you can purchase directly from the Treasury or through a bank for as little as $25. They have a low interest rate that corresponds to inflation and they are sold at face value. They mature in 30 years. EE savings bonds are a similar product that is purchased in much the same way.

Treasury Inflation Protected Securities or TIPS are kind of bond with an interest rate that is pegged to inflation. That means the TIPS rate rises and falls with inflation which protects money from inflation.

Treasury Bonds and Taxes

Treasury bonds are exempt from state and local income taxes but interest on them is considered taxable income by the IRS. You will have to file a 1099-INT form with your tax return for any income you earn from a Treasury bond. Any income made from TIPS is also subject to federal income taxes but exempt from state and local income taxes. You will need to file another form called a 1099-OID with your tax return if you have TIPS.

Purchasing Treasury Bonds

The best way for an average person to purchase Treasury bonds is through the Treasury Direct website. This site will allow you to buy bonds directly or to set up payroll deduction purchase programs. You should buy the bonds directly to eliminate brokerage fees and reduce costs.

Are Treasury Bonds a Good Investment?

Treasury bonds are a good investment for the average person. They are safe, relatively liquid, easy to buy, easy to sell and they offer some tax advantages.

Unfortunately the return on them is not necessarily that high. Therefore the average person will need to invest in some other higher return instruments such as stocks or mutual funds. A good strategy would be to put 10% to 20% of your savings in Treasury bonds.

Despite what some people think Treasury bonds are not without risk. The US government has never defaulted on its obligations but many other governments have. The possibility it will default is remote but in August 2011 the respected ratings agency Moody’s threatened to downgrade the US’s rating as a bond issuer. That means Moody’s experts believe the US had a slightly higher risk of defaulting on its obligations. It should be noted that Moody’s did not downgrade and Uncle Sam kept his top bond rating of Aaa. This means there are some risks to US securities but they are low.

Steven Hart is a freelance writer and a Financial Advisor from Cary, IL. He writes about Annuity topics like Annuities Explained, Fixed Income Annuity, and Annuity Leads.

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