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I Bonds are a type of U.S. savings bond that offer tax advantages and are suitable for long-term savings. They provide a way to earn interest that is exempt from state and local taxes and can be tax-deferred at the federal level. This article explains how to use I Bonds effectively for tax-advantaged saving.
Understanding I Bonds
I Bonds are issued by the U.S. Treasury and earn interest based on a combination of fixed and variable rates. They are designed to protect against inflation and are available in denominations starting at $25. The interest accrues monthly and compounds semiannually.
Tax Benefits of I Bonds
The primary tax advantage of I Bonds is that the interest earned is exempt from state and local income taxes. Additionally, federal income tax on the interest can be deferred until the bonds are cashed or reach maturity, whichever comes first. This allows for flexible tax planning.
Using I Bonds for Saving
To maximize tax benefits, consider purchasing I Bonds through the TreasuryDirect website. You can buy up to $10,000 in electronic bonds per calendar year. For additional savings, you can also buy paper bonds with your tax refund, adding another $5,000 annually.
Hold the bonds for at least one year to avoid penalties. If you cash them before five years, you forfeit the last three months of interest. After five years, you can redeem the bonds without penalty and enjoy tax advantages.
- Buy bonds through TreasuryDirect or with your tax refund
- Hold for at least one year to avoid penalties
- Redeem after five years for full interest
- Benefit from federal tax deferral
- Enjoy exemption from state and local taxes