- 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

How much house can I afford

Home buying 101, evaluating one of your most important financial decisions.

View Course »

Timing Your Spending

How to pay less by changing when you purchase.

View Course »

TurboTax Articles

Are You Exempt From Health Care Coverage?

The Affordable Care Act, or Obamacare, is an individual mandate that requires all eligible Americans to have some form of basic health coverage by 2014. Those without insurance will receive a penalty when they file their tax returns ? that is, unless they have an exemption. TurboTax's Exemption Check can help you find out whether or not you qualify for an exemption.

Essential Tax Forms for the Affordable Care Act

The Affordable Care Act (ACA), also referred to as Obamacare, affects how millions of Americans will prepare their taxes in the new year. The law now includes penalties for all who haven?t obtained health insurance -- and those penalties are expected to be paid at tax time. The ACA also provides tax credits to help people pay for insurance, and you can claim those credits when you file your taxes. The Internal Revenue Service (IRS) has introduced a number of tax forms to accommodate the ACA.

Mortgage Refinance Tax Deductions

When refinancing a mortgage to get a lower interest rate or obtain more favorable loan terms, you're really just taking out a new loan and using the money to pay off your existing home loan. In general, the same tax deductions are available when you're refinancing a mortgage as when you're taking out a mortgage to buy a home.

How to Determine if You Have Minimum Essential Coverage (MEC)

The Affordable Care Act, also known as Obamacare, requires most Americans to have health insurance that meets a government standard known as "minimum essential coverage," or MEC. Whether your insurance qualifies as MEC depends not on the plan itself, but on how you obtained your coverage.

Rental Property Deductions You Can Take at Tax Time

Rental property often offers larger deductions and tax benefits than most investments. Many of these are overlooked by landlords at tax time. This can make a difference in making a profit or losing money on your real estate venture. If you own a rental property, the IRS allows you to deduct expenses you pay for the upkeep and maintenance of the property, conserving and managing the property, and other expenses deemed necessary and associated with property rental.

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