Savings Bonds as an Inheritance

When savings bonds are part of an estate, there can be some confusion about what to do with them. Savings bonds do not have to be redeemed immediately, but the beneficiary may have the name changed on them.

Taxes on Accrued Interest
Savings bonds are not treated like other traded securities, such as stocks and bonds. Interest on the bonds is taxable in the estate or in the deceased’s final tax return. The beneficiary must pay taxes on the bond’s interest after the date of death. However, it is possible for the estate executor or administrator to assign all of the deferred interest to the beneficiary if his/her tax rates are lower than those of the deceased. Called “income in respect of a decedent,” it can result in a bigger inheritance.

Step Up Basis
Stocks and bonds that are in an estate have a step up basis. This means that that the original value of the investment is changed to the value at the date of death, and there can be large tax savings.

Savings bonds, however, do not get a step up in basis. This is due to the fact that savings bonds do not really appreciate in value; they simply accumulate interest which is tax deferred. The value of a savings bond is always a combination of its accumulated interest and its purchase price, and it cannot be sold for more or less on a secondary market. Instead, if it is to be sold, it can only be sold back to the government at the original price and interest. So, it is not treated the same way in an estate as other investments.

Beneficiary's Taxes
The beneficiary’s taxes on savings bonds interest are not due in the year the bonds are inherited if the bonds are not sold. It is possible to defer taxes for years by holding the inherited bonds until final maturity or by converting them to HH Bonds.

However, one’s future tax rate instead of one’s present rate and other financial planning issues should be taken into consideration about cashing savings bonds immediately or holding them. When a beneficiary decides to cash in bonds at a later day, he/she will receive Form 1099, which will cover all accrued interest over the bond’s life, even if the estate has paid taxes previously. It is imperative, therefore, to know how much tax was paid and if the interest was being reported annually. In such a situation, only the interest earned in the final year would be taxable.