The Treasury and the IRS Get Creative on Savings Incentives

A few weeks ago the Treasury Department and the IRS announced an important change to the 2009 tax form: the inclusion of a box that allows tax filers to receive their refunds as I Savings Bonds.  If you have been looking to buy Treasury bills or bonds to protect your assets or this option appeals to you, it is never too early to find out more about it.

I Savings Bonds are similar to the relatively new (and popular) TIPS in that they are protected against inflation, but that is where their similarities end.  While the inflation adjustment on TIPS comes through coupons – i.e., the value of the coupon is paid out every 6 months and is based on the principal, which is adjusted according to inflation – interest on an I Savings Bond is calculated as a combination of a fixed rate and inflation, but is accrued and only paid out when you cash the bond (for other comparisons, see TreasuryDirect’s comparison chart).

I Savings Bonds are also non-transferable.  That is, you cannot sell them to someone else, though the IRS claims that for I Savings Bonds issued via 2010 taxes, joint- or co-ownerships will be available.  But for now, you can still cash out I Savings Bonds whenever you want after holding them for at least 12 months and up to 30 years.  If you cash them before 5 years, you lose three months interest, but there is no penalty otherwise.

Tax Considerations.  There are two important tax issues to consider as you decide on whether to opt in for I Savings Bonds.  First, the interest accrued on the Bond is generally subject to federal income tax, through not state and local income tax.  You can choose whether to claim interest every year or to defer it all until you cash in the Bond.

Second, if you are 24 years old or older when the I Saving’s Bond is issued, using its earnings for qualified higher education expenses may earn you the exception to the rule above.  If you are single and have a MAGI of up to $82,100 (or $130,650 if married filing jointly), you may be eligible to exclude from federal taxes all or part of the interest earned from I Savings Bonds.  Note, however, that if you are receiving the I Savings Bond as a refund for your 2009 taxes, you will only be able to redeem it in early 2011 at the earliest (12 months after issuance).  This exclusion is therefore only relevant if you are at least 24 years old in early 2010 and expect to be in school in 2011 or later, particularly since this first batch of I Savings Bonds can only be issued in the taxpayer’s name and cannot be transferred.

If you have been interested in buying a Treasury bill or bond for a while, getting the I Savings Bond as a tax refund may be a convenient option since, unlike buying a bill or bond directly, it does not require a pre-existing account with the Treasury.  And if you think you will be in school in 2011 onwards, this may be a great opportunity to boost your savings.

To learn more about this tax refund option, visit the IRS’ FAQs page on I Savings Bonds.

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