Paper vs. electronic I-Bonds

Investing Strategies Retirement Investing
1

I bought I-Series Savings bonds in 2001. At that time, the Treasury Department allowed a person and also a Revocable Living Trust to buy I-Bonds separately even though they have the same Social Security number. That’s what I did. My paper I-Bonds are in my safe deposit box at the bank.

Is there any advantage in turning these paper bonds into electronic I-Bonds? Would there be a problem since I have separate ownership for myself and as the trustee of my trust?

The Treasury calls the conversion from paper to electronic “SmartExchange.”
https://www.treasurydirect.gov/indiv/research/indepth/smarte…

**When electronic bonds reach final maturity and are no longer earning interest, they will be paid automatically, and the proceeds deposited to your Zero-Percent C of I in your Primary Account. You can use all or some of the proceeds to purchase new securities or cash the C of I to your bank account, in full or in part.** [end quote]

These I-Bonds will have been earning 3% + inflation for 30 years. That’s a lot of interest. I’m afraid that converting the paper bonds into electronic will cause an involuntary lump sum distribution that would trigger a large tax bill at maturity. If I keep them as paper bonds, I can gradually redeem them to spread out the tax hit. They wouldn’t be earning interest but that might be a better scenario.

Advice?

Wendy

2

When electronic bonds reach final maturity and are no longer earning interest, they will be paid automatically, and the proceeds deposited to your Zero-Percent C of I in your Primary Account. You can use all or some of the proceeds to purchase new securities …

Does this mean that you can re-invest the whole amount into I-bonds, or are you still subject to the $10K/SS# maximum? Like you we bought before the $10K cap and will have a considerable amount coming due in the same year, not to mention the interest.

IP

3

<Does this mean that you can re-invest the whole amount into I-bonds, or are you still subject to the $10K/SS# maximum?>

I don’t know the answer to this but I’ll bet you a quarter that they will force us to follow the new rules and will not allow us to simply roll over the I-bonds.

Wendy

4

I bought my I bonds at the same time. About 6 years ago I converted them to electronic bonds. That did not cause a taxable event. It’s just a “paperwork” swap.

As far as “that’s a lot of interest”, in 9+ years when they mature my understanding is they are considered cashed and you have to pay taxes on all that interest anyway.

What’s “C of I” mean?

5

I’m afraid that converting the paper bonds into electronic will cause an involuntary lump sum distribution that would trigger a large tax bill at maturity. If I keep them as paper bonds, I can gradually redeem them to spread out the tax hit. They wouldn’t be earning interest but that might be a better scenario.

Yes, they would automatically be cashed out. From Treasury Direct https://www.treasurydirect.gov/indiv/research/indepth/ibonds…

When electronic I Bonds in a TreasuryDirect account stop earning interest, they are automatically cashed and the interest earned is reported to the IRS.

That said, I’m not sure that you will have a choice, given that you’re supposed to report the interest in the year that the bonds reach maturity, whether or not you’ve cashed them. From a bit further down on the same Treasury Direct page

When must I report the interest on my tax form?

You have a choice. You can

o report the interest every year
o put off (defer) reporting the interest until you file a federal income tax return for the year in which the first of these events occurs:
- you cash the bond and receive what the bond is worth, including the interest, or
- you give up ownership of the bond and the bond is reissued, or
- the bonds stops earning interest because it has reached final maturity

Since the Treasury Department knows your SSN and when the bonds mature, I’m not sure why they wouldn’t be able to report the interest to the IRS for paper bonds, just like they do for electronic bonds, whether or not you’ve cashed them.

AJ

7 Likes
6

Advice?

One way to spread out the tax hit over multiple years and minimize the tax hit would be to change reporting the interest over to the annual method, rather than waiting until they mature. Especially since, under current law, the tax rates are due to return to their previous higher rates in 2026, 5 years before the bonds mature, you could get most of the interest taxed at today’s lower rates.

From IRS Pub 550 https://www.irs.gov/pub/irs-pdf/p550.pdf (I added some bolding to show that the IRS also indicates that interest is to be reported in the year the bonds mature.)

Reporting options for cash method taxpayers. If you use the cash method of reporting income, you can report the interest on Series EE, Series E, and Series I bonds in either of the following ways.

1. Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year in which they mature. (However, see Savings bonds traded, later.)
Note. Series EE bonds issued in 1990 matured in 2020. If you have used method 1, you generally must report the interest on these bonds on your 2020 return. The last Series E bonds were issued in 1980 and matured in 2010. If you used method 1, you generally should have reported the interest on these bonds on your 2010 return.

2. Method 2. Choose to report the increase in redemption value as interest each year.

You must use the same method for all Series EE, Series E, and Series I bonds you own. If you do not choose method 2 by reporting the increase in redemption value as interest each year, you must use method 1.

Change from method 1. If you want to change your method of reporting the interest from method 1 to method 2, you can do so without permission from the IRS. In the year of change, you must report all interest accrued to date and not previously reported for all your bonds.

Once you choose to report the interest each year, you must continue to do so for all Series EE, Series E, and Series I bonds you own and for any you get later, unless you request permission to change, as explained next.

Change from method 2. To change from method 2 to method 1, you must request permission from the IRS. Permission for the change is automatically granted if you send the IRS a statement that meets all the following requirements.
1. You have typed or printed the following number at the top: “131.”
2. It includes your name and social security number under “131.”
3. It includes the year of change (both the beginning and ending dates).
4. It identifies the savings bonds for which you are requesting this change.
5. It includes your agreement to:
a. Report all interest on any bonds acquired during or after the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest; and
b. Report all interest on the bonds acquired before the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest, with the exception of the interest reported in prior tax years.

You must attach this statement to your tax return for the year of change, which you must file by the due date (including extensions).

AJ

5 Likes
7

One way to spread out the tax hit over multiple years and minimize the tax hit would be to change reporting the interest over to the annual method, rather than waiting until they mature. Especially since, under current law, the tax rates are due to return to their previous higher rates in 2026, 5 years before the bonds mature, you could get most of the interest taxed at today’s lower rates.

Not sure if Wendy is in the same boat, but half of ours mature in one year and the other half the next, so we would divide the tax hit over two years that way, just by waiting for maturity. That may be better than playing catch up on all the bonds all in the same year.

IP

8

Yes, they would automatically be cashed out.

One more moving part particularly for anyone hitting their 60s. I don’t have any anymore but because of sort of required bond purchases when my husband was working, I did have a tracking programs for all of the US Bonds, whatever the type.

9

These I-Bonds will have been earning 3% + inflation for 30 years. That’s a lot of interest. I’m afraid that converting the paper bonds into electronic will cause an involuntary lump sum distribution that would trigger a large tax bill at maturity…
Advice?

I don’t have advice about balancing when/how the interest payment hits, but the following might be usable for you:
-In the year the one-time interest hits, take an extra large charitable contribution. Do that by not donating the year before or year after, and you won’t have to give more than you were anyway, just concentrate the giving into the year you need the deduction.
-May out your 401k and deductible IRAs in the year you need the tax break.
-Pay an extra house payment to get 13 months of deductible interest (a regular monthly payment made early, not an extra payment to be applied to principle)
-Pay an extra property tax payment the year you need to maximize your tax deductions
-If you are doing Roth conversions, skip the year you have high one-time income
-If you are drawing from an IRA, consider drawing from a Roth, or trying to push some IRA withdrawal into a different year

Not all of that is feasible for every person, but it might come in useful for you or others in similar circumstances.

There are a lot of cases where it pays to be hot and cold in alternate years vs. being lukewarm every year. Having a lot of deductions one year and none the next means you get a lot of deductions one year and the standard deduction the next, vs. the standard deduction every year. Again, maybe the numbers won’t let you benefit from doing this, but it’s worth running the numbers each way.

2 Likes
10

I did have a tracking programs for all of the US Bonds, whatever the type.

This is what we use. Super easy to update and view:

https://www.treasurydirect.gov/indiv/tools/tools_savingsbond…

IP

2 Likes