How to Avoid Paying Taxes on a Savings Bond

Savings bonds can be a safe way to save money for the long term while earning interest. You might use savings bonds to help pay for your child’s college, for example, or to set aside money for your grandchildren. Once you redeem them, you can collect the face value of the bond along with any interest earned. It’s important to realize, however, that interest on savings bonds can be taxed. If you’re wondering how you can avoid paying taxes on savings bonds there are a few things to keep in mind. Of course, one key thing to keep in mind is that a financial advisor can be immensely helpful in minimizing your taxes.

How Savings Bonds Work

Savings bonds are issued by the U.S. Treasury. The most common savings bonds issued are Series EE bonds. These electronically issued bonds earn interest for up to 30 years. Depending on when you purchase Series EE bonds, they may earn either a fixed or variable interest rate.

You can buy up to $10,000 of EE bonds each year for a particular Social Security number, and that’s based on the first named owner on the bond. So, for example, you could buy $10,000 for yourself and $10,000 for your child as long as your child was listed as the first owner on that bond.

When Do You Pay Taxes on Savings Bond Interest?

When you’ll have to pay taxes on Treasury-issued savings bonds typically depends on the type of bond involved and how long you hold the bond. The Treasury gives you two options:

Report interest each year and pay taxes on it annually
Defer reporting interest until you redeem the bonds or give up ownership of the bond and it’s reissued or the bond is no longer earning interest because it’s matured

According to the Treasury Department, it’s typical to defer reporting interest until you redeem bonds at maturity. With electronic Series EE bonds, the redemption process is automatic and interest is reported to the IRS. Interest earnings on bonds are reported on IRS Form 1099-INT.

It’s important to keep in mind that savings bond interest is subject to more than one type of tax. If you hold savings bonds and redeem them with interest earned, that interest is subject to federal income tax and possibly federal gift taxes (highly unlikely as the per-person cap is $10,000 and the gift tax exemption is $17,000). You won’t pay state or local income tax on interest earnings but you may possibly pay state or inheritance taxes if those apply where you live.

How Can I Avoid Paying Taxes on Savings Bonds?

Whether you have to pay taxes on savings bonds depends on who owns it. Generally, taxes are owed on interest earned if you’re the only bond owner or you use your own funds to buy a bond that you co-own with someone else.

If you buy a bond but someone else is named as its only owner, they would be responsible for the taxes due. When you co-own a bond with someone else and share in funding it, or if you live in a community property state, you’d also share responsibility for the taxes owed with your co-owner or spouse.

Use the Education Exclusion

With that in mind, you have one option for avoiding taxes on savings bonds: the education exclusion. You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you’re using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent. Only certain qualified higher education costs are covered, including:

Tuition
Fees
Some books
Equipment, such as a computer

You can still use savings bonds to pay for other education expenses, such as room and board or activity fees, but you wouldn’t be able to avoid paying taxes on interest.

Additionally, there are a few other rules that apply when using savings bonds to pay for higher education:

Bonds must have been issued after 1989
Bond owners must have been at least 24 years of age at the time the bonds were issued
Education costs must be paid using bond funds in the year the bonds are redeemed
Funds can only be used to pay for expenses at a school that’s eligible to participate in federal student aid programs

If you’re married you and your spouse have to file a joint return to take advantage of the education exclusion. Any money from a savings bond redemption that doesn’t go toward higher education expenses can still be taxed at a prorated amount.

There are also income thresholds you need to observe. For 2023, if you’re married and filing a joint return, this tax break starts to phase out when adjusted gross income exceeds $137,800. It’s completely phased out after $167,800. For heads of households and single filers, the 2023 phase-out starts at $91,850 and is completely phased out after $106,850.

Roll Savings Bonds Into a College Savings Account

Another strategy for how to avoid taxes on savings bond interest involves rolling the money into a college savings account. You can roll savings bonds into a 529 college savings plan or a Coverdell Education Savings Account (ESA) to avoid taxes.

There are some advantages to either approach. With a 529 college savings plan, you can continue saving money on a tax-advantaged basis for higher education. You won’t pay any taxes on money that’s withdrawn for qualified education expenses. If you have multiple children, you can reassign the account to a different beneficiary if one child decides he or she doesn’t want to go to college or doesn’t use up all the money in the account.

Contributions to 529 college savings accounts aren’t tax-deductible at the federal level, though some states do allow you to deduct contributions. You don’t have to live in any particular state to invest in that state’s 529 and plans can have very generous lifetime contribution limits. Keep in mind that gift tax exclusion limits still apply to any money you add to a 529 every year.

Coverdell ESAs have lower annual contribution limits, capped at $2,000 per child. You can only contribute to one of these accounts on behalf of a child up to their 18^th birthday. Withdrawals are tax-free when the money is used for qualified education expenses. But you have to withdraw all the funds by age 30 to avoid a tax penalty.

Bottom Line

Savings bonds typically offer a lower rate of return compared to stocks, mutual funds or other higher-risk securities. But they can be a good savings option if you want something that can earn interest over the long term. Minimizing the taxes you pay on that interest may be possible if you have children and you plan to use some or all of your savings bonds to help pay for college. Talking to a tax professional can also help with finding other college tax savings strategies.

Tips for Investing

Consider talking to a financial advisor about the best ways to manage savings bonds in your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Savings bonds purchased on behalf of grandchildren don’t receive the same tax treatment for higher education purposes. Generally, the education exclusion only applies if the grandparent is claiming a grandchild on their taxes as a dependent. If your parents are interested in helping pay for your child’s college expenses, you may encourage them to open a 529 college savings account instead, then roll the bonds into it to avoid paying taxes on interest earned.