Saving bonds come in two different types: Series EE, which pays a fixed interest rate for 30 years, and Series I, which also pays interest for 30 years, but the rate is inflation-indexed.
What does the difference between the two, inflation-indexed mean?
An inflation index is used to track changes in the price level of an economy over time. It shows how the same item costs less, the same, or more compared to what it cost a year ago.
Inflation-indexed securities guarantee a return higher than the rate of inflation if it is held to its maturity; it makes sure that your interest is not consumed by inflation.
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Where to Buy Savings Bonds
You can no longer buy savings bonds in paper form; the whole process has been moved online. Bonds are safe and solid long-term investments to gain a nice amount of interest. These low-risk bonds can be purchased straight from the U.S Treasury Department’s official website treasurydirect.gov.
You have to create an account on this website in order to purchase bonds. There are also possibilities for monthly plans of automatic payments that let you buy savings bonds directly from your paychecks, making the process easier than ever.
For those that want a paper-based bond, there is one exception when the Treasury issues them instead of a virtual one. That is if you purchase a Series I savings bond through your tax refund. If you later change your mind and would rather have it more secure online, you can convert paper bonds to electronic ones through SmartExchange.
It is just as easy to cash them out as buying them; for paper-based saving bonds, you can liquidate them at most banks. However, not all banks offer this possibility, so you may need to call first if you want to cash your bonds out. Once you are at the bank, you will have to fill out paperwork and show your identification.
If you own electronic bonds, you can just log in to your TreasuryDirect account and cash them online. They will have the amount sent straight to your savings or checking account.
How Much Do They Cost?
When you purchase a savings bond, you pay the face value of it. For example, for a $50 bond, you pay $50. You can choose how much you want to spend, as they offer different bonds with various values.
However, there is a limit to how much you can buy per year. You can buy for a maximum of $10,000 worth of each series. This means that if you buy both Series I and Series EE all in all you can spend up to $20,000 each year on savings bonds.
You can also decide to gift savings bonds to your family members or friends for birthdays, weddings, graduations, or for any occasion.
Once you have decided to buy a bond, you need to pay tax just as you would for any income you make. But how much do you have to pay exactly, and is there any way to not pay tax at all?
There are no state and local taxes imposed on savings bonds. However, the IRS will want a share of the amount of interest your bonds earn each year, but you have a choice as to when to pay the tax. You can choose not to pay any tax until you redeem your bonds and collect your interest, or you can pay each year on the accumulated interest.
The government poses a tax on bond interest at your marginal tax rate. You must pay 3.8 percent Medicare tax if you earn more than $200,000 personally or $250,000 as a couple. The tax is based on the amount of adjusted gross income or your investment income that exceeds these amounts.
Education Tax Exclusion
If you, your spouse, or any of your dependents decide to pursue higher education, this is something really important to keep in mind. You can avoid paying taxes on bonds interest if you use the money earned on qualified higher education costs:
- Equipment (e.g. Computer)
- Some qualified books
Additionally to these qualified costs, there are qualifying rules to be able to use this tax exemption:
- The bonds were issued after 1989.
- The owner of the bonds was at least 24 years old on the first day of the month in which the bonds have been issued.
- You must pay for the education costs the same year you redeem the savings bonds.
- You must use all the income of the redeemed bonds to pay for the education costs.
- The school must be eligible to participate in a federal student aid program with the U.S. Department of Education.
- If you are married, you must file a joint tax return.
There are income thresholds as well; single tax filers can earn a maximum income of $82,350 to benefit from full exclusion. This amount for married couples who file jointly is $123,550. If you are over these limits, the interests of the bond you can exclude are reduced in correlation with how much higher the income becomes. This reduction goes on until eventually, it phases out altogether.
Savings bonds are non-transferable, therefore you can not donate the bond itself to a charity. However, the cash that you receive when redeeming the bond can be donated. If you choose to do so, you can deduct the amount donated from your taxable income and avoid taxes on it.
The charity you choose must be considered a charity according to the Internal Revenue Service. You also need to receive documentation from the charity that states the date and the amount of the donation made.
When you are preparing your taxes, you have to itemize your deduction with Form 1040’s Schedule A, and enter the amount as a charitable deduction.
Tax on Inherited Savings Bonds
In case you inherit a savings bond, the first thing you need to do is to determine the value and interest that is being earned. Since 2002 this was made easier with bonds being issued electronically and allowing owners to check it online. In the case of older bonds, you can also figure it out online with the Savings Bond Calculator of the U.S. Department of the Treasury.
Once the value, interest rate, and date of maturity are determined, you can cash it in or they can reissue it in your name. Before deciding which is the better option for you, it is important to understand the income tax and administrative requirements.
- If the bond is already matured and stopped earning interest, it is of course not a question, and you should cash it in.
- If the bond is still earning interest, it may be better to hold it. The interest rate might be significantly higher than any other low-risk investment, depending on the date it was issued and the type of savings bond it is.
- Most people choose to pay the tax on the interest of their savings bonds at the time they want to cash it out and do not pay it yearly. As a result of this, the one who inherited it will owe the tax on all the interest accumulated.
- If the bond is reissued in the inheritor’s name, they can choose to pay tax on the interest accumulated up until the date of death of the original bondholder and pay tax each year from then on or pay at the time they choose to cash out the savings bond.
- Another option of this is to report the interest accumulated up until the death in the final income tax return of the original bondholder. This can reduce the income tax in some cases, though it may have to be paid by someone else than the inheritor of the bond.
- Whoever ends up paying the income tax on the bond is entitled to a tax deduction for the portion of federal estate tax that is attributable to the interest on the inherited savings bond.
Are Saving Bonds a Good Investment?
Saving bonds were viewed as a great choice traditionally if you wanted to achieve a long-term goal or wanted to set aside money for when you attend college.
Without a doubt, saving bonds are best if you use them for education, as that is the only non-taxed option. If you have been given a savings bond as a child by a grandparent or your parents, your bond might just mature in time for you to use it for college.
However, this is a lot of times not the case for bondholders, and their bonds can not pay for their education as they mature in decades, and the yearly return is not that high.
All in all, saving bonds are low-risk investments, so it is a great choice in uncertain times. If you know that you might need to cash out your investments fast, saving bonds are easy and fast to liquidate. But with the investment risk being almost non-existent, the return can not be as high as some might want to achieve.
While you might not want to put all your money into savings bonds, it is still a great choice for anyone who wants to build a well-diversified portfolio.
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