Types

• There are two common types of savings bonds, known as EE and I. EE bonds are sold at half their face value, and gradually increase to their face value over the length of their term. If rates increase, they can go above their face value as well. I bonds are sold at face value and earn a rate of return above that amount for as long as the term lasts, making them more akin to real bonds.
  
  

Interest

• When tax laws refer to savings bond interest, they usually mean the interest profit that savings bond owners make. The interest rate itself does not affect taxes, only the profit that is made through that interest rate. Investment profits are taxed according to what type of investment they are, when the profit was made and what market the profit was made in. Savings bonds are protected from certain taxes.
  
  

Exemption

• When interest is exempt, that means that the tax has no effect on the profit, even if it would normally fall under that tax's purview. Savings bond interest is exempt from state and local taxes. This means that state taxes on investments do not apply to savings bonds and city taxes, which rarely affect investments, also fall under the exemption.
  
  

Federal Taxes

• Federal taxes do apply to savings bonds. While the bonds skip by state laws, investors still need to pay capital gains tax on the bonds when they mature and are cashed in. However, there are some exceptions to this law that allow certain investors to bypass taxes entirely. These usually involve students. For example, if the profits are used to pay tuition, then investors are not affected by federal taxes.
  
  

Other Benefits

• Savings bonds have other benefits besides state and local tax exemption. They are widely available--investors can buy them from banks, post offices and other government institutions. They are offered by the federal government, which makes them extremely reliable and low-risk. Also, savings bonds come in small amounts, making them easier for youth to invest in.