totalnoobie wrote: ↑Sat Sep 22, 2018 6:14 pm
SIL recently discovered he has ~20k in EE bonds from the early 1990s that are currently paying 4% each year with final maturity in the early 2020s, wondering if he and DD should start paying taxes on the interest this year and every year going forward.
I deal with this issue, although in a different context: elderly parents own(ed) mid-1980s to early 1990s vintage EE bonds and I need to figure out the optimal path for redeeming them without going over the next IRMAA (increased Medicare premiums) threshold, yet keeping that nice 4% yield as long as possible. (Yes, all the ones maturing 2017 and before have already been properly redeemed and reported.)
As far as I can figure out, these are the options:
Option 1: The pay-for-education option. There are lots of little gotchas associated with this option, and I think this is the little gotcha that will likely rule out this option for the OP's SIL ("son-in-law", right? ("sister-in-law" doesn't seem to fit the context):
You [ the bond owner] must be at least 24 years old on the first day of the month in which you bought the bond(s).
Source:
https://www.treasurydirect.gov/indiv/pl ... cation.htm
I'm guessing that if they are in graduate school, your son-in-law and daughter are in late 20s, early 30s? And there is no way that your son-in-law was 24 in the early 1990s when the bonds were purchased?
However, this does bring up the questions of "How did your SIL come into possession of these bonds?" It is certainly possible that a parent or grandparent purchased them in his name when he was a child, and he has owned them all along. But - if, by any chance, they were inherited - especially if inherited relatively recently - he'll probably want to verify whether or not all the accrued interest for those bonds was reported on the final tax return (or estate tax return, if any) of the person he inherited them from. Reporting the accrued interest on a decendent's final tax return is an option - might have happened; might not have happened. If some tax may have already been paid on the decedents final tax return, see this post for the nitty gritty on IRS documentation on how your SIL avoids paying tax on the same interest twice: "Steps for Redeeming/Reporting/Paying interest & penalties for inherited matured EE Series Savings Bonds"
viewtopic.php?t=239929#p3752731
Options 2. The "just-wait-until-they-mature" option.
Option 3. The "Hold to maturity, but switch from deferring tax to paying tax annually. (all accrued interest on all EE bonds must be reported on taxes in the year the switch is made)" option.
Option 4. The "Gradually redeem some bonds early (keeping under some pre-selected tax threshold), re-invest proceeds (minus tax paid on interest) into something else"
As far as I can tell, choosing among these options is a matter of spreadsheets and figuring out which option will leave the most after-tax money on the date that the EE bonds would have matured if they had been held to maturity. (This is assuming that the total amount of interest earned by all the bonds is worth the trouble of setting up the spreadsheets to start with.)
And I think maybe the main point of your question to the forum is how to set up the compounding calculations in the spreadsheet for the various options.
I have a spreadsheet for myself to help figure out my parents' situation, but I'm not confident enough in it to share it. Broadly my method was
1. figure out what the interest would be on an EE bond held to maturity (using a compound interest calculation), then subtract out (estimated) taxes (and (estimated) extra IRMAA surcharges, in my case) that would be owed in that year.
2. Figure out what interest would be on an EE bond if I redeemed the bond this year, then subtract taxes that would be owed this year. Choose something to reinvest the after-tax amount in. Use compound interest equation - using an after-tax-equivalent-yield for the new investment - to figure out the value of the new investment on the date that the EE bond would have matured if I had held it to maturity. (In my case, it would be reinvested in some sort of bond/CD so figuring out the new after-tax-equivalent yield is a lot easier than if I were to reinvest in stocks, like a younger person might. It is also easier for me because there is less uncertainly in what my retired parents' tax rate is likely to be in the early 2020s vs a younger couple who will be working in an as-yet-unknown-job-with-unknown-salary in the early 2020s.)
3. Compare final after tax $ return of Steps 1 and 2.
The option that the OP mentions - switching from deferring the interest to reporting the interest annually - wasn't a good option for my parents' situation, so I don't have any spreadsheets set up for that option.