During periods of high inflation, making money in I-bonds was easy. Now bondholders are sobering up during tax season.
Series I Savings Bonds have been a popular investment during periods of high inflation, for people seeking a safe and reliable way to grow their savings. However, when it comes to tax season, many bondholders find themselves in the dark about the intricacies of reporting and paying taxes on their Series I bonds.
Understanding Series I Bonds
Issued by the U.S. Department of the Treasury, Series I bonds (also known as I-bonds) provide a low-risk investment option with inflation protection. Series I bonds accrue interest based on a fixed rate and an inflation rate, ensuring that your investment keeps pace with rising prices.
Leveraging tax-deferred growth
One of the key advantages of Series I bonds is that the interest earned is tax-deferred at the federal level. This means that you don't have to report or pay taxes on the interest until you redeem the bonds. While this feature provides a tax advantage during the holding period, it's essential to understand the implications when it comes time to cash in your bonds.
Options for paying taxes on Series I bonds
Report Annually: Interest on I bonds is exempt from state and local taxes but taxed at the federal level at ordinary income-tax rates. You can pay taxes every year on the interest instead of waiting until you cash out, but that can be a headache, especially since TreasuryDirect does not send 1099s. This method allows for a consistent reporting schedule. You only pay taxes on the interest you've received, which can be advantageous if you redeem the bonds over multiple years; however you may potentially have a higher tax liability in a single year if you redeem a significant amount of bonds.
Hold Until Maturity (30 Years): You can hold your Series I bonds until they reach their 30-year maturity date, at which point they stop earning interest. You then report the interest income on your Form 1040 for the year the bonds mature. The advantage to this method is that you defer tax payments until maturity, potentially allowing for lower tax rates in the future. However, you may also end up a surprise tax liability by deferring for 30-years, if you don't keep an eye on how much interest you owe.
Use Bonds for Qualifying Educational Expenses: You can redeem Series I bonds and use the proceeds to pay for qualified educational expenses, such as tuition and fees. The greatest advantage to this is that the interest is tax-free when used for qualified education expenses. For many people, this provides a practical way to offset education costs.
The bottom line
Understanding your options when it comes to paying taxes on Series I bonds is crucial for optimizing your finances. Whether you choose to report your bonds annually, hold until maturity, or utilize them for education expenses, being informed enables you to make decisions aligned with your financial goals. Remember to consult with a tax professional to ensure compliance with the latest tax regulations and to make the most of your Series I bonds while minimizing tax implications.
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