Welcome to WCS Money Tutorials.
Today’s topic is United States Savings Bonds.
Earn a guaranteed 9.62% interest rate, without risk, which is not subject to state or local
taxes, and I will show you how they can be free of federal taxes.
Savings bonds are issued by the United States government.
Interest is added to the bond at the start of each month, much like a savings account,
which is why they are called savings bonds.
Savings bonds are non-marketable securities, so they cannot be sold.
Instead, both the principal and interest are paid at maturity or when the bond is redeemed.
The maximum term is 30 years.
Thereafter, no additional interest is earned.
They can be purchased commission-free at TreasuryDirect.gov.
There are 2 types of savings bonds: Series I and Series EE.
Series EE bonds pay a fixed, low rate of interest.
Series I bonds pays an interest rate that is part fixed and part variable.
Currently, the fixed portion is 0%, so there is only a variable portion.
In May 2022, the interest rate for Series I bonds was 9.62%, much higher than the Series
EE bonds.
Besides the low interest rate, Series EE bonds have no advantages over I bonds, so there
is no reason ever to buy them.
I will not discuss anything more about EE bonds,
but you can learn more about them at TreasuryDirect.
The interest rate of an I bond is a composite of a fixed rate and a variable rate based
on inflation.
Both the fixed rate and the variable-rate are set twice annually by the U.S. Treasury
on the 1st business day of May and November.
The fixed rate for individual bonds does not change over their 30-year life.
The variable-rate is based on the semi-annual inflation rate over the previous 6 months
for which inflation data is available.
The variable-rate applies to all outstanding I bonds for 6 months regardless of the issue
date, even if the government sets a new rate during the 6-month term in the bond.
Interest is added to the account at the start of each month, but the added interest does
not earn additional interest until the next 6-month period after the issue date.
Therefore, interest is compounded semiannually from the bond’s issue date.
However, you earn a full month of interest if you own the bond for any part of a month.
If the bond is redeemed within 5 years, then 3 months of interest is forfeited.
This is the formula for figuring the composite interest rate.
Currently, since the fixed rate is 0, the composite rate consists only of the semi-annual
inflation rate, which is annualized to make it easy to compare to other investment returns.
The equation for the composite rate has 2 terms based on the fixed rate, but the last
term does not add much.
However, when they become available, buying I bonds with a higher fixed rate, even if
the inflation component is lower, may be a good investment since the fixed rate never
declines over the 30-year life of the bond.
The fixed rate was as high as 3.6% on bonds purchased from May to October 2000.
These bonds are now earning more than 10%!
Here is an example in how interest rates are applied to your bonds.
You buy a bond on April 1, 2022, when new bonds earned 7.12%.
This interest rate applies to your bond for 6 months.
The next month, the federal government sets the new interest rate for new bonds on May
1, 2022, to 9.62%, but you continue to earn 7.12%.
At the end of 6 months after your purchase, October 1, 2022, the interest added to your
principal starts earning interest.
So interest is compounded semiannually.
The new 9.62% interest rate set for new bonds applies to your bond at the start of October
2022 to the end of March 2023 regardless of the new interest rate that will be set on
November 1, 2022.
Your bond will start to earn that interest in April 2023 for the following 6 months.
And so on.
(Interest rates are annualized.)
Bonds are not subject to either state or local taxes.
However, bonds may be subject to federal taxes, but there are ways to minimize or even avoid
federal taxes.
Taxes can be saved for children even if the proceeds are not used to pay for educational
expenses.
By putting the bonds in the child’s name only and filing a tax return for the child
and electing to report the interest annually, the child’s tax rate will apply to the child’s
income, so if it is less than the standard deduction for children with investment income,
then there is no tax.
When the bond matures, the child receives the proceeds tax-free.
However, if the child receives significant income, then kiddie tax rules may apply.
In this case, taxes on the interest may be deferred until the bonds are redeemed, when
the interest will be taxed at the child’s rate if she is at least 19 years old, or 24
years old if she is a full-time student.
Redemptions for younger children will be subject to the kiddie tax rules.
Co-owners must pay any taxes on bond interest when the bonds are redeemed that is proportional
to the amount of money they contributed to the purchase price.
So if a father pays 75% of a savings bond for his daughter, who then redeems it 20 years
later for the full amount, then he must pay 75% of any tax on the interest.
Federal taxes can also be avoided on interest used to pay for qualified educational expenses.
To receive this tax-free treatment, the following requirements must be satisfied:
If a bond is used to pay for your educational expenses, then you must be the owner of the bond.
To pay expenses for your child’s education, then you or your spouse, or both, must own
the bond.
Your child may be a beneficiary but not a co-owner.
There are also some redemption requirements, the primary requirement being that the educational
expenses must be incurred in the same tax year the bonds are redeemed.
Form 8815 must be filed to exclude interest that was used to pay for qualified higher
education expenses.
The tax savings for the educational bond program is limited by income, specifically modified
adjusted gross income, or MAGI.
MAGI = taxable income + additional income that would otherwise be excluded or deducted
when calculating normal tax liability.
For instance, IRA deductions would have to be added back to taxable income.
The income limits phase out over a range of $15,000,
or $30,000 for married couples filing jointly.
The phaseout starts at $85,800.
Joint filers have a higher range.
These MAGI limits depend on the tax year when the bonds are redeemed, not when they are purchased.
This screen shows the formula and an example for calculating the tax-free portions of bond
redemptions if MAGI exceeds the phaseout threshold but is still below the phaseout limit.
Simply multiply the redemption amount by the amount your MAGI exceeds the phaseout threshold
divided by the phaseout range, then subtract that from the redemption amount.
If the bond proceeds exceed qualified educational expenses, then this formula determines how
much of the interest is tax-free.
The tax-free interest equals the percentage of the interest equal to the percentage of
qualified educational expenses over the total bond redemption amount.
This screen also shows 2 color-coded examples on how to calculate the tax-free portion of
redemptions.
For any calendar year, these are the limits on the acquisition of savings bonds per recipient:
• $10,000 in electronic I bonds.
• $5000 in paper I bonds.
Business entities, trusts, and estates, including living trusts and estates, can purchase up
to $10,000 of electronic I bonds.
These limits apply to each individual or entity per calendar year whether the bonds are purchased
or received as a gift.
There is no limit to buying bonds as gifts for other individuals, but the total value
of bonds received by the recipient cannot exceed the above limits for the calendar year.
There are some exceptions to limits on bond acquisitions.
The primary exception is that bonds transferred to you because of the death of the original
owner do not count toward your limit.
As stated earlier, bonds cannot be sold.
Instead, they are redeemed by the federal government.
Bonds must be held for a minimum of 1 year.
If redeemed before 5 years, then the last 3 months of interest is forfeited.
However, this penalty can be mitigated by buying right before the end of the month and
selling right after the beginning of the month, since you earn a full month of interest
if you owned the bond for any portion of the month.
A bond must be registered.
Registering the bond determines who owns the bond and who can redeem it.
The owner can specify a beneficiary, who must be a person, who will receive the bond if
the owner dies.
A bond may have another owner, but if one owner is a person, the other cannot be an entity.
Either owner of a co-owned paper bond may cash the bond without the approval of the
other owner, but most other transactions require the signature of both owners.
If one owner of a co-owned bond dies, then the other owner becomes the sole owner.
Paper bonds are sold in these 5 denominations.
These bonds must be purchased in multiples of $50, since that is the smallest denomination.
The per calendar year limit is $5000 per tax return.
You can only buy paper bonds with your tax refund, which is limited to the lesser of
$5000 or your tax refund, by filling out Part 2 of Form 8888, Allocation of Refund.
You do not need to open a TreasuryDirect account; just follow the instructions on Form 8888.
Once your tax return has been processed by the IRS,
your paper savings bonds will be mailed to you.
You can buy paper bonds for yourself and 2 other individuals, but the total purchase
cannot exceed the lower of your tax refund or $5000.
You can also designate co-owners or beneficiaries for the other individuals.
Designate someone as a beneficiary by checking the appropriate box.
You can redeem paper I bonds at some
local financial institutions or by mail.
To redeem by mail, use FS Form 1522.
If your paper I bonds are lost or destroyed,
then you can easily replace them with an electronic
bond in your TreasuryDirect account or receive payment for the lost bonds.
The paper bonds are then invalidated by TreasuryDirect.
Individuals are limited to receiving $10,000 of electronic bonds and $5000 of paper bonds,
but you could buy much more than this for your family or if you have various entities,
such as a limited liability company or a trust.
Remember that each tax return is limited to $5000 of paper I bonds, so if you are married
and file jointly, then $5000 is your limit, but if you file separately, then your spouse
can also buy $5000 of paper bonds, for a total of $10,000.
You can also add up to $10,000 for each entity that you own or control.
Remember that all of these limits are per calendar year.
To buy bonds commission-free at TreasuryDirect.gov,
you must set up an account.
Go to website and select the tab for Individuals.
Click the link to open the account.
Click on the link to TreasuryDirect.
This shows you a summary of the 3 steps you must take to establish an account.
To get started, click on the APPLY NOW button.
The only thing you will need to open an account is your personal information, your Social
Security number, a checking or savings account, and an email address.
Enter your name, Social Security number, and the other requested personal information.
Enter your banking information and email address.
Click the checkbox to certify certain information.
Review the information to ensure that it is correct.
Then click SUBMIT.
Choose a personalized image or caption that will help to verify that you are on the authentic
TreasuryDirect website.
Choose a password.
And the answers to at least 3 security questions.
Then click SUBMIT.
Then you reach the final screen thanking you for opening an account.
You can also give bonds as gifts.
To give an electronic bond as a gift, you must know the recipients full name, Social
Security or taxpayer-identification number, and their TreasuryDirect account number.
TreasuryDirect also provides 2 videos on buying
and delivering gifts, as well as a step-by-step tip sheet.
You deliver your gifts with the TreasuryDirect tools for giving gifts.
Here you can see the screen for the delivery request details.
This is the details screen for the delivery request.
You can get more information on giving gifts from TreasuryDirect.
TreasuryDirect has good videos on how to use their website and how to do the most common
tasks, such as setting an account and how to buy bonds.
Just search for TreasuryDirect videos, then click the appropriate link.
You can see their current selection here, which will be expanded in the future.
Each video is only 2 minutes long.
Topics include setting up an individual account, setting up a entity trust account or a corporate
entity account, how to buy and deliver savings bonds as gifts, how to reset your password,
and how to edit your bank account information in TreasuryDirect, as well as other topics.
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