Savings Bonds & I Bonds: Tax Rules When You Cash Out

I Bond Tax Rules When You Cash Out: The Answer

Cashing out EE or I savings bonds creates a federal tax bill on the interest. The interest lands on your return as ordinary income, never as a capital gain.

State and income taxes never apply to savings bond interest anywhere in the country.

The federal tax waits until you cash out, until the bond stops earning at 30 years, or until reissue. Whichever comes first controls. This guide covers the 2026 rates, the redemption math, the annual election, and the education exclusion.

It also covers what happens on inheritance and gifts. Bond interest follows different rules than the marketable Treasury gains in our bonds capital gains guide. The difference surprises many investors.

What EE and I Bonds Are and How They Earn

Savings bonds are Treasury-issued instruments you buy directly from the government, not securities traded on any market. Series EE bonds pay a fixed rate for 30 years. Bonds issued after 2005 also carry a double-value guarantee at the 20-year mark.

Series I bonds combine two components. A fixed rate lasts for the bond's life, plus a semiannual inflation adjustment tied to CPI. The TreasuryDirect program site publishes the current components every May 1 and November 1.

Those limits restart every January, and paper I bonds can only be bought using a federal tax refund. The caps apply per person, not per household.

Both types stop paying anything after 30 years. The oldest bonds in a drawer may be dormant rather than growing.

What Bonds Bought Around 2026 Actually Pay

Rates reset every six months, so any article quoting one number ages fast. For orientation, consider the May through October 2025 window. I bonds then carried a 1.10 percent fixed rate, for a 3.98 percent combined annual rate.

EE bonds issued in that window carried a 2.70 percent fixed rate with the 20-year doubling guarantee. Check the current TreasuryDirect tables before buying, because the inflation component swings with CPI while your fixed rate locks forever. The fixed rate is the part worth waiting for, since it compounds for three decades.

Why Bond Interest Is Not a Capital Gain

Here is the distinction that trips stock market investors. Marketable Treasury securities, like a 10-year note, produce capital gains if you sell for a profit. Savings bonds never trade, so they never produce capital gains at all.

Every dollar earned on an EE or I bond is interest. It arrives on Form 1099-INT and taxes at your ordinary rates. A saver in the 24 percent bracket owes 24 percent on bond earnings.

A long-term stock gain in the same hand might owe 15 percent.

The state tax exemption partially balances that equation, since most states tax interest at full ordinary rates.

The Tax Math at Cash-Out, Worked

The redemption statement makes the tax number easy to find. You receive principal and accumulated interest separately, and only the interest is taxable. Suppose you bought $10,000 of I bonds and cashed them out 15 years later for $16,800.

The $6,800 of interest lands on your federal return as ordinary income for that year. At the 22 percent bracket, the federal bill is $1,496, and your state sends no bill at all.

Timing the redemption year can shrink that bill. A retiree can cash bonds during a low-income year and stay in a low bracket. Ordinary brackets top out far lower than the capital gains version, so the math rewards care.

Spreading redemptions across several Januarys and Decembers splits the interest into friendlier brackets. Our retiree tax guide covers bracket management in more depth.

The Early Redemption Penalties, Priced

Savings bonds enforce patience with two rules. No bond can be redeemed in its first 12 months under any circumstance, even hardship. Between 12 months and five years, redemption forfeits the most recent three months of interest.

After year five, nothing is forfeited at all. The penalty is calculated automatically at redemption, so no paperwork or election is involved.

Reporting Interest Annually Instead of at the End

Most holders defer everything to the end, but the tax code offers an election. You can report each year's interest annually as it accrues, on your federal return every year. The default cash method waits until redemption instead, which is simpler and interest-free.

Annual reporting fits exactly one common situation. A child's bond, in the child's own name, can earn little enough to owe nothing each year. Once you elect annual reporting for a bond, the choice binds that bond for life, including every future owner.

Deferral is usually the better deal even for large holdings, because the interest compounds untaxed for decades. No interim tax applies and no phantom income rules bite. The entire gain lands in whatever bracket you occupy at redemption.

Choose the redemption year deliberately and the deferred model is hard to beat.

Households phasing into retirement should coordinate bond cash-outs with the withdrawal order strategy for maximum effect.

The Education Exclusion That Erases the Interest

Savings bonds carry a unique education benefit no other interest enjoys. Interest on qualifying EE and I bonds can escape federal tax entirely. The redemption must pay higher education expenses in the same year.

The owner must have been 24 or older at purchase, and the expenses must qualify. Modified adjusted gross income must also fall under annual phase-out limits.

The exclusion covers tuition and required fees, and room and board only within defined caps.

The IRS interest exclusion topic page publishes the current MAGI ranges each year.

The phase-outs bite hardest for households most likely to hold bonds. Check the ranges before counting on the benefit. Married filing separately can never use the exclusion.

Parent-owned bonds redeemed for a child's college count the parents' income, not the student's. Our thresholds guide explains how to model the MAGI line before redeeming anything.

Inherited and Gifted Bonds: Who Owes the Tax

Death and gifting both move bonds around with the tax attached. Heirs inheriting these bonds owe tax on all the built-up interest, with no step-up rescue.

Marketable assets get their gains wiped at death, but bond interest never qualifies for that treatment. Instead, the accrued interest at death is reported and paid on the decedent's final return.

The estate's income tax return can settle it in some cases. The heir then owns the bond with a fresh deferral going forward. This contrasts sharply with the basis step-up on stocks described in our inherited property guide.

Gifts between living owners work differently. A bond can be reissued to a new owner. That owner inherits both the deferral and the eventual tax bill.

The original owner owes nothing at the gift, because no redemption occurred. Keep the purchase records with the bond, since the eventual 1099-INT will name whoever redeems it.

Bonds Inside Trusts, UTMAs, and Retirement Accounts

Where the bond lives changes the paperwork more than the tax. Bonds titled in a custodial UTMA account belong to the child for tax purposes. Kiddie tax limits then shape the annual bill if annual reporting is elected.

Trust-owned bonds report through the trust's filings, and the tier system from trust taxation applies at redemption. You cannot hold savings bonds inside an IRA or employer plan at all, because only the Treasury issues them directly. Estate plans should inventory paper bonds carefully, since lost paper bonds require a Treasury recovery process that heirs rarely enjoy.

Savings Bonds Versus Marketable Treasuries for Tax Purposes

The Treasury sells two different worlds of products, and their tax profiles barely overlap. The table below aligns the choices for a taxable account.

Investors holding TIPS or Treasury notes realize genuine gains when rates move. Those gains follow the ladder from our rates breakdown. Inflation adjustments on TIPS are taxable annually, which makes TIPS awkward inside taxable accounts.

Savings bonds invert that trade: no annual tax, but no capital treatment either. The right pick depends on whether deferral or capital rates matter more in your bracket.

The Bottom Line on Cashing Out Savings Bonds

Savings bond earnings are ordinary interest, deferred until cash-out and exempt from every state. The education exclusion occasionally erases them entirely. The redemption year is your one tax decision.

Place it in a low bracket and split large stacks across years. Mind the three-month penalty before year five.

Heirs also settle accrued interest through the estate, rather than receiving a step-up. Held and cashed deliberately, savings bonds remain one of the most tax-gentle instruments a federal-only household can own.

Paper Bonds, Electronic Bonds, and Lost Bonds

Format matters at redemption time, mostly for logistics. Electronic bonds inside TreasuryDirect redeem in seconds, and the proceeds plus the interest breakdown appear in your transaction history. Paper bonds require a paying agent such as a bank, or a mail-in process through Treasury for larger amounts.

Buying paper I bonds requires a federal tax refund, and the cap sits at $5,000 per return annually. Lost paper bonds can be replaced through Treasury's recovery process using Form 1048, though estate situations make that slower. Digitize any paper stash now, recording serial numbers, issue dates, and owner names in one inventory.

A Smart Redemption Order for a Mixed Stash

Households holding decades of accumulated bonds should cash them in a deliberate order. When rates have fallen, resist cashing the highest-yielding bonds, since old high-rate bonds are most valuable to keep.

Sorting by fixed rate takes minutes and prevents expensive mistakes. Cash the lowest-rate bonds first if you need the money regardless, letting the high earners keep compounding.

Bonds past year 30 pay nothing, so redeem those immediately in every scenario. Check each bond's issue month as well.

Interest posts on six-month anniversaries, so redeeming just after a posting date captures a full period. A one-hour inventory session often finds several months of free interest hiding in the timing.