- Days left

Uncle Sam's Easiest Tax Shelter, for the Average American

'Close up photograph of U.S. Savings Bonds, selective focus.Similar image:'
Getty Images
Most people think of tax shelters as being complicated, expensive strategies that only the wealthiest taxpayers use in order to cut their tax bills to Uncle Sam. But what many investors don't know is that a very simple and easy-to-understand investments -- U.S. savings bonds -- offer some attractive tax attributes that can produce unexpected tax savings on your return. Let's take a look at three ways that savings bonds can save you money at tax time.

You Don't Have to Pay Tax on Interest Until You Cash Them In

Most people use Individual Retirement Accounts, 401(k)s and other tax-deferred retirement accounts in order to avoid having to pay taxes on their investment income and capital gains until they need the money in retirement. But even when you hold savings bonds outside a retirement account, they give you the same tax deferral as IRAs and 401(k)s, making savings bonds much different from bank certificates of deposit and other more conventional fixed-income investments.

Ordinarily, with most interest-bearing assets, the Internal Revenue Service makes you pay taxes on the interest income that those assets pay you. Indeed, in some cases, you even have to pay taxes on interest you don't receive, such as in the case of a zero-coupon Treasury bond or an inflation-protected bond.

But for savings bonds, you never have to pay tax on the interest you've earned until you cash in the bond. With the maximum maturity period on savings bonds of 30 years, that can save you from high taxes for decades while you wait to find the best time from a tax perspective to cash them in and use the money.

You Never Have to Pay State Income Tax on Savings Bonds

Once you cash your savings bonds in, then you'll generally owe federal income tax on the interest. But as with other U.S. government obligations, you won't have to pay any state income tax that would ordinarily be due on interest income. Although all Treasury bonds share this tax-free trait at the state level, many other income investments, such as bank CDs and corporate bonds, are subject to state income tax and thereby reduce your after-tax return.

Bond Interest Used for Educational Purposes Can Be Tax-Free

One great benefit of savings bonds is that if you use the proceeds from a bond redemption to pay qualified educational expenses, then you could be eligible to exclude the interest income entirely on your tax return -- effectively paying no tax at all. To qualify, you have to have been 24 or older when the bond was issued, your income has to fall below certain limits, and you have to pay tuition and fees for yourself or a spouse or dependent. For 2013, the benefit begins to phase out for single filers above $74,700 in gross income and joint filers above $112,050, completely disappearing at levels $15,000 and $30,000 above those respective figures.

Be Smart About Your Savings Bonds

The downside to savings bonds right now is that because interest rates are low, the amount of income you'll get from investing in savings bonds is limited. Currently, Series I savings bonds pay 0.2 percentage points above inflation, which equates to a 1.38 percent rate for the first six months. Series EE bonds pay just 0.1 percent, but they're guaranteed to double if you hold them for 20 years, equating to an annual rate of 3.5 percent.

Nevertheless, with these tax breaks, savings bonds are worth considering. For more information on savings bonds, check out the U.S. Treasury's website at savingsbonds.gov.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+.

Increase your money and finance knowledge from home

Intro to different retirement accounts

What does it mean to have a 401(k)? IRA?

View Course »

Banking Services 101

Understand your bank's services, and how to get the most from them

View Course »

TurboTax Articles

Cities with the Lowest Tax Rates

The total amount of tax you pay reaches far beyond what you owe the federal government. Depending on where you live, most likely you're required to pay additional taxes, including property and sales tax. The disparity between the amount of tax you pay in a low-tax city and that in a high-tax city can be dramatic. Living in any of these 10 cities could save you a bundle, although the exact amount may fluctuate based on your income and lifestyle choices.

Cities with the Highest Tax Rates

Much ado is made in the press about federal tax brackets, but cities can carry a tax bite of their own. Even if you live in a state that has no income tax, your city may levy a variety of taxes that could eat away the entire benefit of living in an income tax-free state, including property taxes, sales taxes and auto taxes. Consider all the costs before you move to one of these cities, and understand that rates may change based on your family's income level.

Great Ways to Get Charitable Tax Deductions

Generally, when you give money to a charity, you can use the amount of that donation as a deduction on your tax return. However, not all charities qualify as tax-deductible organizations. While there are many types of charities, they must all meet certain criteria to be classified by the IRS as tax-deductible organizations. There are legitimate tax-deductible organizations in many popular categories, such as those listed below.

A Freelancer's Guide to Taxes

Freelancing certainly has its benefits, but it can result in a few complications come tax time. The Internal Revenue Service considers freelancers to be self-employed, so if you earn income as a freelancer you must file your taxes as a business owner. While you can take additional deductions if you are self-employed, you'll also face additional taxes in the form of the self-employment tax. Here are things to consider as a freelancer when filing your taxes.

Tax Deductions for Voluntary Interest Payments on Student Loans

Most taxpayers who pay interest on student loans can take a tax deduction for the expense ? and you can do this regardless of whether you itemize tax deductions on your return. The rules for claiming the deduction are the same whether the interest payments were required or voluntary.

Add a Comment

*0 / 3000 Character Maximum

1 Comment

Filter by:
Steelhead Shuffle

Witholding for paychecks should be done on a percentage basis, not the allowances listed on a W-4. Some places I worked at part time used to allow me to claim 0 tax + 15%. Weather I made a lot one week and a little the next I had the proper amount taken out for ME and never had to pay at the end. A situation that gets many dual job holders pissed off at tax time.

March 13 2014 at 3:04 PM Report abuse rate up rate down Reply