Savings bonds are a great way to invest income conservatively. Not only is the bond guaranteed by the United States government, but it also pays interest based on current market rates.
While the interest on these bonds is taxable at the federal level when redeemed, there is one way to avoid it.
First, most of these bonds must be held for at least 6 months before they can be redeemed. However, to get the most out of your investment, I highly suggest holding for a long period of time.
Interest on Series EE savings bonds are also exempt from local and state taxes. To avoid paying taxes on the bonds at the federal level, you may use the funds from the redemption for college expenses for you, your spouse, or your dependents.
Therefore, an effective tax strategy for parents is to gift savings bonds to their children when they are young. This not only allows the savings bonds to mature and grow interest, but it also prevents the interest from being taxed if it is redeemed to go towards college expenses.
Finally, if the funds redeemed are not used toward college expenses, then the income is reported along with your other interest income on your tax return — if it is less than $1,500. If the income from the bonds is greater than $1,500 then it is reported separated on a Schedule B for filers using form 1040.
If you do plan on using the income for college expenses, then you also have 2 choices on how to report the interest income. First, you can report the incremental increase on your tax return each year. Or second, you can report the total interest income upon redemption.
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