In the 1970s, U.S. Savings Bonds were a popular savings tool. Grandparents purchased them to help pay for college for grandchildren. Many investors used them to build funds for retirement. The concept was simple and attractive, especially for risk-averse savers. At purchase, the buyer paid half of the face value and later (usually 20 years) the bonds matured at twice what you paid for them. A $1,000 investment yielded $2,000 when it reached maturity.

What follows is a true story with a disappointing ending, but one that has a lesson for everyone.

In this story, the tax misstep had the following ingredients:

• Converted Series E savings bonds with deferred interest;
• Series HH savings bonds with annual taxable interest;
• Uncashed savings bonds that no longer earn interest;
• Little help or advice from the bank; and
• Confusing information from federal tax authorities about future tax obligations.

Joe purchased Series E saving bonds each year in the 1970s. With half down and the promise of double the value upon maturity, Joe amassed a nice $140,000 retirement fund. After 20 years the bonds matured. Joe did not yet need the money, so he converted them to Series H savings bonds. This effectively deferred the interest income on the old Series E bonds since the bonds were not cashed.

With the new Series H savings bonds, Joe paid federal income tax each year on the interest earned. Meanwhile, the taxable interest earned from the series E bonds continued to be deferred.

Joe received word that his series H bonds had reached maturity and would no longer pay interest. He told his grandson to go to the bank and cash in the bonds. Afterall, why have bonds that no longer pay interest? The grandson had financial power of attorney so he did as his grandfather asked.

The following year, Joe received a deficiency letter from the IRS notifying him that he owes more than $24,000! Joe did not realize that the deferred interest of $70,000 from the original bonds would be due upon cashing in his bonds.

Lessons for all of us

• Never disregard 1099s or printed details. When the grandson cashed the bonds, if he looked closely on the face of the bonds, he may have noticed the deferred interest. But it would contradict what his grandfather had told him. Further, Joe may have received a Form 1099 that was disregarded, as he believed he was already paying the tax as needed on the annual interest from the H bonds.
• Old savings bonds can be confusing. There are many different issues and flavors of savings bonds. When you see any uncashed bonds, conduct the necessary research to understand your potential obligations. This is especially true for bonds past their maturity date.
• Ask before you sell. Always understand the tax consequences BEFORE you sell any property. Even the most innocent of transactions can have their own tax implications. Always consult with a professional before you sell assets.
• Tax planning matters. While Joe would always have owed federal income tax when he cashed the bonds, he could have reduced his effective tax rate by cashing them over time instead of all in one year. In this case, it exposed a meaningful amount of income to a higher tax rate. With a little pre-planning, his transaction may have resulted in a much more favorable outcome.

Because neither banks nor federal taxing authorities believe it is their duty to help you make knowledgeable tax decisions, taxpayers are responsible for accessing professional advice. If you have a tax conundrum or you’re considering the sale of any investments, our professional advisors are here to help!

Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.