Consider Purchasing Series I Savings Bonds With Your Tax Refund

If you’re looking for a safe investment that pays a higher interest rate than savings accounts or CDs and is inflation-resistant, Series I savings bonds could be a good investment vehicle for your mid to long-term investment goals.

Our tax planning experts have listed some of the most common questions from clients regarding some of the benefits of using your tax refunds to purchase Series I savings bonds.

What Are Series I Savings Bonds?

Series I bonds are non-marketable, long-term, interest-bearing investments backed and sold by the U.S. government. They offer investors a guaranteed fixed rate — ensuring a safe investment for up to 30 years.

Like all bonds, Series I savings bonds are a form of debt security — an agreement between the issuer/U.S. government and the borrower with the aim of raising money from investors willing to lend them money for a certain amount of time. Despite recent hiccups with Congress and budget discussions, government bonds have always been the safest place for an investment.

Often, Series I bonds are intended for redemption for life events like paying off student loans, a down payment on a home for kids or grandkids, or a mortgage payoff, which happens to be conveniently termed at 30 years.

How Are Series I Savings Bonds Issued?

U.S. investors (at least 18 years of age with a valid Social Security number), business entities, and trusts, including revocable trusts, can purchase I bonds electronically online or as paper bonds.

Purchase the electronic version from the U.S. Government through the Treasury Direct website. This purchase method allows you to track precisely how much your bonds are worth at any given time. Investors can purchase anywhere from $25 up to $10,000 per year.

In contrast, paper bonds must be purchased with a federal tax refund using IRS Form 8888. The minimum purchase amount is as low as $50, to the maximum of $5,000.

Keep in mind that the bonds must be held for one year before they are redeemed, and if they are redeemed before holding them for five years, three months of interest is automatically forfeited. Due to the restrictions on the length of time and interest forfeiture, I bonds are not the best option for quick access to funds; instead, they should be considered long-term investments.

It is also important to point out that unlike some other types of bonds, like Treasury and Municipal bonds, I bonds are not eligible for purchase, trade, or sale in secondary markets. Keep this in mind if short-term liquidity is a reality for you.

What Interest Rates Do Series I Savings Bonds Earn?

I bonds earn a combined rate of interest: a fixed rate and an inflation rate. The fixed rate never changes because it is set when an investor purchases the bond. Announced every year by the Department of Treasury in May and November, the fixed rate applies to all bonds issued during the following six months.

The inflation rate, on the other hand, changes every six months in May and November based on the Consumer Price Index.

For I bonds issued between November 1, 2023, and April 30, 2024, the combined rate of interest is 5.27%. This includes the fixed rate of 1.30% and the linked inflation rate of 3.97%. Interest on I bonds is guaranteed to never go to zero.

What Is the Taxability of the Interest Earned on Series I Savings Bonds?

Interest income for Series I bonds is taxable at the federal level, not at the state level, but it is subject to estate, gift, and inheritance taxes. The interest earned during the life of the bond is added back to the value of the bond — earning more interest on the interest.

For cash-method taxpayers who do not report the interest on their bonds yearly, the interest is reported and taxable when the bonds are redeemed. In other words, individuals have the flexibility to choose their tax payment approach. They can opt to report the yearly earned interest and pay taxes incrementally or defer taxes until the bond is redeemed.

Additionally, there’s the option to switch methods during the process, though completion of IRS Form 3115 is necessary when transitioning from annual reporting to deferring taxes until redemption.

In certain circumstances, federal taxes are avoidable if the bond proceeds are utilized for qualified education expenses in the redemption year.

Here’s a helpful example: Let’s say you are in a high-income tax bracket, and over the years, you have been able to put away about 10 thousand dollars for your child’s college fund with this type of bond. Certain limitations apply, but you may be able to redeem the funds tax-free if you choose not to defer until maturity to avoid a tax bracket jump.

Get in Touch

For all scenarios, remember to check with your tax advisor to ensure you have made the proper considerations. Still have questions? Tax season is a good time to ask. Contact us to schedule an appointment.