Tax Advantages of Series EE Savings Bonds
Benefits New Investors Often Don't Know
One of the biggest benefits of Series EE savings bonds is the exemption they earn from state and local taxes. This is especially important if you are in a high-income tax bracket in a state that taxes wealth heavily such as New York. The bottom line is that it means more money in your pocket.
Series EE Savings Bonds Can Defer Income Taxes Until Redemption or 30 Years
If you elect cash based reporting on your income tax filings with the IRS, you can defer payment of taxes on the interest income of your Series EE savings bonds until you redeem the bond or 30 years from the date it is issued. As was explained in the Beginner's Guide to Series EE Savings Bonds, each savings bond is a zero coupon bond. That means that you don't actually get checks in the mail for the interest you are owed like you would with a corporate bond or municipal bond. Instead, the value of the interest owed to you is added to the bond principal, and you get it when the bond matures, or you sell it back to the government (this is called "redeeming" the bond).
Series EE savings bonds will pay interest for up to 30 years from the date they are issued. This means that a bond with a $5,000 face value could end up being worth $20,000 or $30,000. This is a point that most new investors don't understand, so it's important that you grasp the concept.
Series EE Savings Bonds Can Provide Big Tax Benefits for College or Education Savings
If you invest in Series EE savings bonds for college or other qualified education expenses, you can exclude part or all of the interest you earn over decades from your income taxes when the bonds are redeemed. The rules are extensive, but here's the summary:
- You must redeem the Series EE savings bond in the same year you incur the expenses for post-secondary education, such as tuition and fees.
- You must have been at least 24 years old on the first day of the month in which you purchased the bonds.
- If you are using Series EE savings bonds for your own education and want the tax benefits, the bonds must be registered directly in your name.
- If you are married, you must file a joint return to qualify for the tax exclusion of the Series EE savings bond interest income. At the time this article was written, the Defense of Marriage Act precludes the IRS from recognizing legally valid marriages of same-sex couples in the large part of the United States that permits such unions so gays and lesbians cannot take advantage of this program for their spouses if the bonds are held in their name.
- There are income requirements established by the government that you must meet depending on your situation. These are updated frequently, but for the fiscal year 2008, they were as follows: "For single taxpayers, the tax exclusion begins to be reduced with a $67,100 modified adjusted gross income and is eliminated for adjusted gross incomes of $82,100 and above. For married taxpayers filing jointly, the tax exclusion begins to be reduced with a $100,650 modified adjusted gross income and is eliminated for adjusted gross incomes of $130,650 and above. Married couples must file jointly to be eligible for the exclusion."
- The post-secondary institution that you attend must qualify for the Series EE savings bond program by being a university, college, or vocational school that meets federal assistance stands by offering programs such as guaranteed student loans.
Qualified educational expenses and fees include items such as:
- Tuition and fees including required course expenses.
- Expenses that benefit you, your spouse, or a dependent for whom you claim an exemption.
- Books, room, and board are not considered qualified education expenses.
The amount of qualified expenses is reduced by the sum of any scholarships, employer-provided educational assistance, fellowships, or other tuition benefits and both the principal and the interest of the EE savings bonds must be used to pay the qualified expenses to exclude the interest from your taxable income. According to the United States Treasury, "If the amount of eligible bonds you've cashed during the year exceeds the amount of qualified educational expenses paid during the year, the amount of excludable interest is reduced pro rata."
An Alternative Method for Using Series EE Savings Bonds for Education Expenses
There is a more advanced method of using Series EE savings bonds for education expenses. This approach is detailed by the United States Treasury on the TreasuryDirect site and it involves putting the Series EE savings bonds in the name of the child with the parents listed as the beneficiary (not co-owner). Although the child will pay Federal taxes on the interest income, this can be structured to be far lower than would be due if the parents held the bonds. This approach is somewhat complex and should be done in conjunction with a qualified, well-respected accountant that is familiar with investment tax rules.