What you'll learn:
➤ What Are Investment Bonds?
U.S. investment bonds offer safety and tax advantages that make them a smart addition to your investment portfolio.
They help spread your risk and provide peace of mind. Let’s break down the basics of savings bonds in a simple, understandable way.
Backed by the US Government
Savings bonds are like financial safety nets, as they are fully backed by the U.S. government. The U.S. government guarantees both the interest payments and the principal amount.
While these bonds are a secure investment, keep in mind they are non-transferable; you can’t sell them to others. However, you have the flexibility to redeem them at any time.
But here’s a catch: if you cash them in before owning them for at least five years, you’ll lose the last three months of interest you’ve earned.
One thing to remember is that investment bonds will never be worth less than their face value, also known as par value. When your bond reaches maturity, you will receive the full par value, no matter what’s happening in the market or with interest rates.
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The tax perks of savings bonds are another attractive feature. The interest you earn from them is exempt from state and local income taxes, which can save you quite a bit of money.
However, this exemption doesn’t apply to federal taxes.
But here’s where it gets interesting: if you use the funds for qualified education expenses and your income falls within the set limit, your earnings might also be exempt from federal taxes.
It’s a bonus that can help you save more when it comes to education expenses.
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➤ Bonds and Education
Did you know that you can enjoy a sweet tax break when using savings bonds for educational expenses? Let’s dive into the details of this fantastic education exclusion feature.
To take advantage of the education exclusion, the savings bond must have been issued after the owner turned 24.
If you’re planning to use I bonds to fund your or your dependent’s education, make sure to purchase the bonds in your name, not the child’s.
For the year 2023, the education exclusion begins to phase out when your modified adjusted gross income (MAGI) exceeds $137,800 for married couples filing jointly and $91,850 for all other filers.
Once your MAGI hits $167,800 for married couples filing jointly and $106,850 for other filers, the exclusion is no longer available. Keep in mind that these limits are adjusted yearly for inflation.
Some Restrictions Apply
Married taxpayers filing separately can’t enjoy this tax break.
Additionally, if the student was gifted the savings bonds or they were purchased in the student’s name before they turned 24, you won’t qualify for the exclusion.
What’s Considered an Eligible Educational Institution?
The education exclusion applies to post-secondary institutions, including vocational schools that meet federal assistance standards.
If they’re part of guaranteed student loan programs, they’re most likely eligible.
Eligible educational expenses cover tuition, fees, lab expenses, and other course-related costs essential for enrollment or attendance.
These expenses can also include activities like sports, games, or hobbies, but only if they are mandatory components of a degree or certificate-granting program.
What’s Not Covered?
Keep in mind that room, board, and books are not considered qualified educational expenses under this exclusion.
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➤ Investment Bonds Types
When it comes to savings bonds, you’ve got a couple of options: EE bonds and I bonds. Here’s what you need to know about these types of bonds and how they work.
EE Bonds (Steady Earners)
EE bonds are a straightforward choice for many. These bonds earn interest regularly for 30 years, or until you decide to cash them. One catch, though: they’re only available in electronic form. You’ll need a TreasuryDirect.com account to buy and manage them.
EE bonds are sold at face value, with a minimum purchase of $25 and a maximum of $10,000 per year. These bonds come with a fixed interest rate that’s set when you buy them. Interest is compounded semiannually, meaning it’s added to your principal every 6 months.
Your bond’s value grows not only because it earns interest but also because the principal increases. You can check the current rate at TreasuryDirect.com.
I Bonds (Inflation Fighters)
I bonds provide protection from inflation. They offer a combined interest rate made up of a fixed rate and an inflation rate, which usually changes every 6 months. Rate updates occur every May 1 and November 1.
The combined rate depends on the issue date of your bond. While I bonds mature fully after 30 years, you can cash them in after just one year. However, if you redeem them in under 5 years, you’ll lose the last 3 months of interest, but the interest earned up to that point is yours to keep.
I bonds sell at face value and can be purchased electronically, with individual yearly limits of $15,000 — that’s $10,000 in electronic I bonds and $5,000 in paper I bonds. Paper I bonds can only be bought using your federal tax refund.
HH Bonds (A Chapter Closed)
HH bonds were available from 1980 until August 2004. They earn interest for up to 20 years, with the final HH bonds no longer earning interest after 2024. Keep in mind that you can’t cash them at a bank or any other financial institution.
To redeem them, you’ll need to mail them using FS Form 1522. If the total value of the bond(s) you’re cashing exceeds $1,000, you’ll have to get your signature certified.
These savings bonds provide various options to help you save and grow your money over time.
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➤ Final Thoughts
In a nutshell, U.S. savings bonds are a smart, tax-advantaged choice to save and cover education costs. Yet, the rules for excluding earned interest can be a bit complex. It’s essential to plan ahead to make the most of this exclusion.
While the interest rates may not be sky-high, your principal is secure, and the U.S. government fully backs your interest payments and redemption value.
If you’re not stashing cash for college, these bonds still provide a safe spot for your money. However, there are other Treasury options out there that offer similar safety with the potential for higher returns.
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〝Wealth is largely the result of habit.〞— John Jacob Astor