When it comes to saving for the future, savings bonds are a popular and reliable choice. They provide a low-risk way to grow your money over time, and the interest earned can sometimes come with tax advantages. However, the relationship between savings bonds and taxes can be complex, leaving many taxpayers uncertain about how to manage their investments come tax season.
If you’re wondering how savings bonds impact your taxes, you’re in the right place. This guide will break down everything you need to know, from how taxes apply to savings bonds to tips on maximizing their benefits. Whether you’re new to savings bonds or a seasoned holder, this is the clarity you’ve been looking for.
What Are Savings Bonds?
Before we jump into the tax details, let’s make sure we’re on the same page about what savings bonds are.
Savings bonds are a type of government-backed investment issued by the U.S. Treasury. They’re considered a safe option for growing your savings, as they are backed by the full faith and credit of the U.S. government. There are two main types of savings bonds available today:
- Series EE Bonds: These earn a fixed interest rate and will double in value if held for 20 years.
- Series I Bonds: These provide protection against inflation by offering a combined fixed and variable interest rate.
Savings bonds are typically purchased to save for long-term goals like college tuition or retirement. However, they also bring financial obligations on tax day, which we’ll explore next.
When Are Savings Bonds Taxable?
One of the biggest questions savings bond holders have is, “Will I owe taxes on this?” The answer largely depends on how and when you cash in the bond. Here are some key considerations.
Income Tax on Interest Earnings
The interest earned on savings bonds is subject to federal income tax but is exempt from state and local taxes. You can choose between two methods of reporting the interest:
- Accrual Method – Reporting the interest as it accrues annually.
- Cash Method – Deferring the interest and reporting it in the year the bond matures or is redeemed.
While the accrual method avoids a hefty payment later, most people opt for the cash method to defer taxes until the bond matures or is cashed in.
Taxes Upon Redemption
If you decide to redeem your savings bond, you’ll owe federal income tax on the total interest accrued over the bond’s life. For example, if you’ve held a Series EE bond for 10 years, you’ll need to report and pay taxes on the interest earned during that entire period when you cash it in.
Gifting or Transferring Bonds
Savings bonds you give as a gift or transfer to another person can also have tax implications. The giver is typically responsible for any tax on accrued interest up to the point of transfer.
Tax-Free Education Uses
One of the biggest tax benefits of savings bonds? They can be used tax-free for qualified education expenses. Under the Education Savings Bond Program, if you redeem a savings bond to pay for tuition and fees, you may exclude the interest from your taxable income. Keep in mind, however, that this benefit is subject to eligibility requirements, including income limits and use at qualifying institutions.
Key Tax Advantages of Savings Bonds
While taxes on savings bonds aren’t entirely avoidable, they do carry some benefits you should be aware of.
1. Federal Tax Deferral
The ability to defer paying federal taxes on savings bond interest until you redeem them allows your earnings to grow over time without the drag of annual tax payments.
2. Exemption from State and Local Taxes
Because you don’t have to pay state or local taxes on savings bond interest, they’re a great way to maximize your after-tax returns.
3. Education Tax Benefits
Planning to use savings bonds to fund education? This is where you can potentially unlock significant tax savings. Check if you qualify for the Education Savings Bond Program to reduce or completely avoid taxes on interest.
4. Simple Recordkeeping
Savings bonds come with an easy-to-access interest record through TreasuryDirect, simplifying your tax reporting process.
How to Report Savings Bond Interest on Taxes
When tax season arrives, the IRS makes it relatively straightforward to report savings bond interest. Here’s how it works:
- Receive Form 1099-INT – When you redeem your savings bonds, the bank or TreasuryDirect will issue you a Form 1099-INT. This form shows the total interest earned.
- Include on Your Tax Return – Report the interest income on your federal income tax return. For most taxpayers, this is entered on Form 1040 under “Interest Income.”
If you’re using savings bonds for education and qualify for interest exclusion, be sure to complete Form 8815 (Exclusion of Interest from Series EE and I U.S. Savings Bonds Issued After 1989).
Frequently Asked Questions
1. Can I avoid paying taxes on my savings bonds?
While taxes on savings bonds are mandatory, you can reduce or eliminate them by using the bonds for qualified education expenses under the Education Savings Bond Program.
2. How long do I have to report savings bond interest?
You must report all accrued interest once the bond matures, typically 30 years after issuance.
3. Do I owe taxes on inherited savings bonds?
Yes, taxes on accrued interest are still owed on inherited savings bonds. The person who redeems the bond will be responsible for the tax.
4. What happens if I never redeem my savings bonds?
Savings bonds stop earning interest after 30 years, but you’ll still need to pay federal tax on the accrued interest unless redeemed earlier.
5. Are there penalties for waiting to pay taxes on a matured bond?
No penalties apply, but you must report all interest once the bond matures—even if you haven’t redeemed it yet.
How to Make the Most of Your Savings Bonds
Savings bonds are a powerful tool for building wealth, but understanding their tax implications helps you make smarter decisions. Here’s how to optimize their value:
- Choose between the accrual and cash tax reporting methods based on your long-term tax strategy.
- Consider using bonds for education to take advantage of tax exclusion opportunities.
- Plan your redemptions carefully so they don’t push you into a higher tax bracket.
If you’re still unsure how to manage your savings bonds or report them correctly on your tax return, our team at SD Mayer & Associates is here to help. Our approachable, jargon-free guidance makes it easy to manage your finances and get the most out of your investments.
DISCLAIMER:
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The services of an appropriate professional should be sought regarding your individual situation.
