I-bond suitability for high tax bracket investors
I-bond suitability for high tax bracket investors
I was surprised to see the wiki article on I Bonds note that they "...may not be a suitable investment..." if you will be in a high tax bracket when they mature. Doesn't this same argument apply to all taxable investments? Are I Bonds in some way RELATIVELY worse than other investment options? (e.g., CDs, high-yield bank accounts, etc.) The example goes on to calculate a miniscule after tax real return, but wouldn't other investments have a similarly poor return for high tax bracket investors?
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Re: I-bond suitability for high tax bracket investors
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Last edited by weltschmerz on Tue Jan 01, 2019 1:40 pm, edited 1 time in total.
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Re: I-bond suitability for high tax bracket investors
I Bonds are particularly subject to adverse tax effects.
1. They have a 30 year maturity duration.
2. Their tax is normally deferred.
2. The entire deferred inflation/interest is taxable at maturity in one lump sum.
You pay interest on savings accounts, CDs, and most other taxable interest sources yearly. I Bonds purchased in someone's 20's will mature in their 50's. This is likely to be peak earning years at higher marginal brackets.
All Savings Bonds are deferred by default, but you can elect for the liability to be due yearly. This can be very advantageous when held by minors where savings bond interest can be tax free, then taxed at their own rate, before being subject to their parents rate. Also, young people early in their careers may benefit from it being taxable while they are in lower tax brackets. However, very few people in these two situations take advantage of this.
1. They have a 30 year maturity duration.
2. Their tax is normally deferred.
2. The entire deferred inflation/interest is taxable at maturity in one lump sum.
You pay interest on savings accounts, CDs, and most other taxable interest sources yearly. I Bonds purchased in someone's 20's will mature in their 50's. This is likely to be peak earning years at higher marginal brackets.
All Savings Bonds are deferred by default, but you can elect for the liability to be due yearly. This can be very advantageous when held by minors where savings bond interest can be tax free, then taxed at their own rate, before being subject to their parents rate. Also, young people early in their careers may benefit from it being taxable while they are in lower tax brackets. However, very few people in these two situations take advantage of this.
Re: I-bond suitability for high tax bracket investors
Good points, thx for the comments. I agree that for many (most?) people, having to pay the tax all at once during peak earning years could make them less optimal than other often-compared investments. But it does seem that if you expect to be in the same tax bracket from your time of purchase through maturity, then they are still a good selection...even more so if you will be in the top bracket no matter what, so there is no chance that the 30 years of deferred income will push you into a new bracket. And of course, if you plan to be in a lower bracket at maturity, that makes them even more attractive.
Re: I-bond suitability for high tax bracket investors
And depending on your income level, they may be completely tax-free, if they are used towards college expenses.15202guy wrote:Good points, thx for the comments. I agree that for many (most?) people, having to pay the tax all at once during peak earning years could make them less optimal than other often-compared investments. But it does seem that if you expect to be in the same tax bracket from your time of purchase through maturity, then they are still a good selection...even more so if you will be in the top bracket no matter what, so there is no chance that the 30 years of deferred income will push you into a new bracket. And of course, if you plan to be in a lower bracket at maturity, that makes them even more attractive.
Cosmo
Re: I-bond suitability for high tax bracket investors
In the current interest rate environment, the tax deferral doesn't mean much. If you stay in the same tax bracket, it is the equivalent of interest on interest being tax free. If you plan on hold them more than 10 years, TIPs have higher yields. If interest rates go up and you sell them in 5-10 years, the tax-deferral is almost meaning.
For $10,000 bond at 2.5% with a 40% tax rate if you pay taxes on I-Bond interest each year for 10 years, you end up with $10,000 * (1 + 0.025*0.6)^10 = $11,605.
If you defer the interest payment, you end up with $10,000 * (1 + 0.025)^10 = $12,801 subtract out 40% of gains = $11681. You've earned $76 or 0.76% more after taxes, 0.08% annually.
For $10,000 bond at 2.5% with a 40% tax rate if you pay taxes on I-Bond interest each year for 10 years, you end up with $10,000 * (1 + 0.025*0.6)^10 = $11,605.
If you defer the interest payment, you end up with $10,000 * (1 + 0.025)^10 = $12,801 subtract out 40% of gains = $11681. You've earned $76 or 0.76% more after taxes, 0.08% annually.
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Re: I-bond suitability for high tax bracket investors
actually if interest rates go up i bonds will probably be ok as their rate(adjusted aevery 6 months) will probably go up also.The main virtue of i bonds over TIPs is that there is no downside risk of losing money which is not clearly true for TIPs unless you buy individual issues
Re: I-bond suitability for high tax bracket investors
I bond interest free from any state and local taxes.
Re: I-bond suitability for high tax bracket investors
I'm specifically talking about I-Bonds bought today having an insignificant tax advantage. If you have I-Bonds bought today returning 0.2%+inflation and the rate for TIPs goes up well above 0.2%+inflation, it wouldn't make sense to continue holding the low-yielding I-Bonds. Their price would have gone done down if they were a 30-year zero-coupon. The awesome thing is that you can choose to sell them early (after 5 years, penalty-free) without losing value.sometimesinvestor wrote:actually if interest rates go up i bonds will probably be ok as their rate(adjusted aevery 6 months) will probably go up also.The main virtue of i bonds over TIPs is that there is no downside risk of losing money which is not clearly true for TIPs unless you buy individual issues
If you sell them in 5-10 years (which appears likely given current interest rates), the tax deferral is nearly useless. Since it is the equivalent of interest on interest being tax-free, both a shorter duration and lower interest rates make the tax deferral less useful. We have both today. If interest rates go up and it looks like I-Bonds will be worth holding for 30 years, their tax-deferral feature will become very useful again.
I did buy I-Bonds a few weeks ago but not because of the tax-deferral feature that makes them insignificantly more tax-efficient than TIPs.