Potential Unique Advantages of Savings I-Bonds

Posted on October 21, 2010 // 6 Comments
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Even though the current interest rates on Series I Savings Bonds aren’t much higher than other alternatives, these I-Bonds do have some unique characteristics that can keep them attractive.

Inflation-Linked Returns

Along with TIPS (Treasury Inflation-Protected Securities), these are the only investments you can make that are explicitly tied to a measure of U.S. inflation. (Some foreign-countries also have inflation-linked bonds.) Interest rates don’t always move perfectly with inflation, so having such protection can be helpful.

Exempt From State and Local Income Taxes

The interest from I-Bonds are exempt from state and/or local income taxes. Of course, this is only an advantage if you are subject to such taxes.

Tax Deferral

You can choose to either report your interest earned on an annual basis (like a bank CD), or have the interest reporting deferred until maturity or redemption. This can be especially advantageous if you are in a relatively high tax bracket now, but sometime in the future you believe you will have at least one year where you will have lower taxable income (possibly on purpose) and thus can redeem at a lower tax rate (perhps even zero). I-Bonds keep earning interest for up to 30 years.

Educational Tax Exclusion

If you meet the requirements, you can even avoid federal income taxes completely when paying qualified higher education expenses at an eligible institution. More information at this TreasuryDirect page.

According to this FinAid.org page (via Bogleheads Wiki), you can even contribute your proceeds to a 529 plan or Coverdell Educational Savings Account.

Series EE and I US Savings Bonds issued after December 31, 1989 may be redeemed tax-free in order to contribute the proceeds to a section 529 plan or Coverdell Education Savings Account. (To take advantage of this, file IRS Form 8815 to claim an exclusion for the interest after rolling the proceeds of these US Savings Bonds into a section 529 college savings plan or Coverdell Education Savings account. Write “529 College Savings Plan” or “Coverdell Education Savings Account” in the answer to 1(b), where it asks for the name of the educational institution. The specific citation in the tax code for this guidance is IRC Section 135(c)((2)(C).)

One of the restrictions is an income phase-out. In 2010, full phase-out occurs at a modified adjusted gross income of $135,100 for married filing jointly filers and $85,000 for single filers.

Filed Under: College & Education, Savings Bonds //
Last updated: August 22, 2018
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Comments

  1. Dan says
    October 21, 2010 at 2:15 pm

    If you buy before the end of the month, per your post on Tuesday, you earn 1.74% the first six months and then 0.94% the following six months.

    So even if rates improve a year from now and you redeem with the 3-month penalty right away, it’s still comparable to CDs available right now. Especially when you factor in the state-tax-free factor, plus the ability to hold on longer tax-deferred if the rate looks good at that time.

    Reply
  2. Royce says
    April 16, 2014 at 8:05 am

    Jonathan,

    I have a question: “In 2010, full phase-out occurs at a modified adjusted gross income of $135,100 for married filing jointly filers and $85,000 for single filers.” What does that mean?

    Reply
  3. Andrea says
    December 22, 2016 at 4:32 pm

    I’m a bit confused about taxation. I bonds are exempt from state and local taxes, but subject to federal taxes, right? So it would be the federal tax that I’m deferring?

    Thanks!

    Reply
  4. misty says
    November 2, 2017 at 7:02 am

    A household with an income of over $135k cannot buy these bonds now?

    Reply
  5. Dan says
    November 2, 2017 at 7:45 am

    Misty, what Jonathan is describing as phasing out at that income level is not purchasing I-bonds, but rather one specific benefit of I-bonds – which is excluding interest income on your redeemed savings bonds in a year that you also made qualified education expenses. The phase out income limit for this benefit has increased since Jonathan’s post, but you can look up the current phase-out income level here: https://www.treasurydirect.gov/indiv/planning/plan_education.htm

    I believe the qualifications to purchase a savings bond are simply to have a social security number. No income limitation there.

    Reply

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