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Now that I found the correct forum for my subject matter, I will re-post.
Question: If someone purchases I-Bonds one year which consequently accrue a lot of interest when redeemed in 30 years at maturity, what might be a way to lessen that final year's tax impact?
Would the purchaser be wise to redeem some of those bonds during years prior to maturity?
An example to explain my question would be an 80 year old person who routinely has an AGI of $25,000 suddenly has an AGI of $250,000 when he/she redeems a bunch of bonds.
Not an expert but your logic makes sense. It seems it would be wise to redeem an amount that would her take up to the top of the 15% bracket for the years prior to redemption deadline. Better paying 15% on that income instead of 30 something %. Also the taxability of SS benefits could be impacted.
I would play around with your tax software using different scenarios.
Better paying 15% on that income instead of 30 something %. Also the taxability of SS benefits could be impacted. I would play around with your tax software using different scenarios.
I appreciate your response. Your answer helps because it shows you see the dilemma we face with these bonds. You made reference to the SS benefits which would probably be subject to huge taxes. 85% of SS benefits might be taxable for two family members filing jointly.
I love I-Bonds and use they and laddered them as my "emergency" fund. They are the highest fixed option going out there. No CD's or MMF's can touch the current rate...
I think you'd need to do a calculation to compare the difference between:
(1)the effect of being in a higher marginal tax bracket due to all bonds maturing at the same time; and
(2)the effect of missing out on the interest payments by redeeming the bonds early.
There's going to be some optimal compromise between options (1) and (2), which will depend on the bonds' fixed and variable rates, the maturity date, and your income. You just need to find it.
EDIT
Actually, wait -- an investor could possibly maximize the after-tax income from his savings bonds by using the accrual method if he is in a lower tax bracket.
You may consider seeking the advice of an accountant, but to me using the accrual method seems like a pretty logical solution for a person that has a relatively low income but a relatively large amount of savings bonds.
All good information. Thanks for taking part in this discussion.
I agree some "math" needs to be done in order to best beat the taxman on this subject. Strange it even becomes an issue since there's little chance I'll be around to see the day of maturity.
ML North - Good post. You have a great idea there regarding the "accrual" method and is something I had not considered before. One potential problem with using the accrual method might be that I would have to "catch up" if I were to make that change. I'm not 100% certain that's the case, but if it is, I'm already too far behind due to substantial earnings. My I-Bonds have more than doubled in value since their purchase. Granted, from this point on things would be more in hand but I would fall into large taxes for the first year that change is made. Do you agree?
Accrual Method: You choose to report the increase in redemption value as interest each year. Once you choose this method, you MUST report the interest every year.
ML North - Good post. You have a great idea there regarding the "accrual" method and is something I had not considered before. One potential problem with using the accrual method might be that I would have to "catch up" if I were to make that change. I'm not 100% certain that's the case, but if it is, I'm already too far behind due to substantial earnings. My I-Bonds have more than doubled in value since their purchase. Granted, from this point on things would be more in hand but I would fall into large taxes for the first year that change is made. Do you agree?
Accrual Method: You choose to report the increase in redemption value as interest each year. Once you choose this method, you MUST report the interest every year.
In order to change from cash-basis to accural you need to pay all interest to date in the first year. That could potentially be a problem, and unfortunately you have to switch accounting methods for all Series EE, E, and I bonds at the same time, so making that change over time is not an option.
So it looks like you need to do a pretty detailed analysis, and the optimal solution may be a mix of the different options: redeeming some near-maturity bonds to lower your tax bracket in subsequent years, switching accounting methods, and holding some to maturity. Keep in mind though that the optimal solution may not necessarily be one in which you pay the smallest dollar amount in taxes -- remember you're trying to maximize your net income, not necessarily minimize your tax obligation.
One tool that may be helpful is the Savings Bond Wizard from treasurydirect.gov. It's a free program with which you can build an inventory of all your savings bonds and get accurate valuations, maturity dates, yields, etc. You can then export the data to Excel to perform your calculations. (I use it for EE bonds. It's incredibly easy to use, and once you build your inventory it's very convenient).
ML - Thanks so much for your thoughtful feedback. You seemed to have touched upon every one of my I-Bond concerns. I'll eke out a way to move forward that gives the best balance between income and [eventual] taxes, thanks in no small part to this discussion.
Yes, I use the Bond Wizard each month to update the value of my bonds. wouldn't know what to do without it.
CouponJack - I like your idea of using these bonds as part of an emergency fund. The earnings on these I-Bonds have been crazy (IMO) and funding a home repair or an unforeseen family issue with them makes total sense.
ML - Thanks so much for your thoughtful feedback. You seemed to have touched upon every one of my I-Bond concerns. I'll eke out a way to move forward that gives the best balance between income and [eventual] taxes, thanks in no small part to this discussion.
Yes, I use the Bond Wizard each month to update the value of my bonds. wouldn't know what to do without it.
CouponJack - I like your idea of using these bonds as part of an emergency fund. The earnings on these I-Bonds have been crazy (IMO) and funding a home repair or an unforeseen family issue with them makes total sense.
Your initial investment in I-Bonds cannot be used for an emergency because you cannot cash in till you hold them for 1 year (and you will pay a 3 month interest penalty). If you want to cash out w/o a penalty, you have to wait 5 yrs.
However, even w/the 3 month interest penalty, I-Bonds are the best thing going because of the higher interest rate than comparible CD's....
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