Savings Bonds (Part 2) - What Happens when the Bond Owner Dies?
Category: Estate and Inheritance Tax, Tax Law and Planning, Probate and Estate Administration, Financial Planning
Savings bonds are a ubiquitous asset. However, dealing with savings bonds as part of an estate can in many ways be more complicated then dealing with other investment assets, such as mutual funds, stocks and bonds, where a broker can coordinate transfer and liquidation efforts. In a prior post Saving Bonds (Part 1) - Learning More about those Bonds - I discussed resources to learn more about the value of any bonds. Here, we are looking at what to do with the bonds as part of an estate, or if you inherit bonds as a result of a person's death.
A few general rules, regardless of what series of bonds (E/EE, H/HH or I):
- Single Ownership: If the savings bonds are owned by one person, and that person dies, the bonds are now owned by the person's estate. The executor, personal representative, or administrator, as the case may be, is the only person authorized to deal with the bonds after a person's death. This means that a probate proceeding will need to be opened so that a person is named by the court to liquidate or transfer title to the bonds.
- Joint Ownership: If the bonds have co-owners, and one owner dies, the bond now belongs entirely to the co-owner. The co-owner may now liquidate the bond, change title to his or her own name, or change title to the surviving owner and another person of the owner's choosing.
- Named Beneficiary: If the bond owner named a beneficiary to the bonds on the bonds (not through her will) then upon the bond owner's death, the bond ownership is automatically transferred to the beneficiary. The named beneficiary may now liquidate the bond, change title to his or her own name, or change title to the named beneficiary and another person of the beneficiary's choosing.
- Estate Tax Consequences: Where the bonds are owned by one person (or by one person who names a beneficiary), 100% of the value of the bonds as of date of death is includible in a person's taxable estate. Where the bonds are owned by more then one person, there is a presumption that 100% of the value of the bonds is includible in the taxable estate of the first person to die. This presumption can be rebutted if the surviving co-owner actually contributed money to buy the bonds. The more likely scenario is that grandma bought a bond naming grandchild as co-owner with grandma's money. In this situation, 100% of the value of the bond on the date of grandma's death is included in her estate, even though she had a co-owner.
- Income Tax Consequences: Interest income on bonds is generally reported only when the bonds are cashed, disposed of (note: a change of ownership is considered a "disposition" of the bonds and interest accrued to that date must be reported at that time), or reach final maturity. Unlike other types of investments, there is no "step up in basis" for savings bonds, and the accrued, but as yet untaxed income, must be reported as some point by the estate or the beneficiaries.
If a person owned bonds in their own name with no beneficiary, reporting the interest on those bonds for federal income tax purposes is the responsibility of either (a) the estate if the executor, personal representative, or administrator as the case may be, redeems the bonds; or (b) the beneficiaries of the estate if the bonds are transferred to them as new owners, in the year in which they redeem bonds or the bonds reach final maturity.
Where there is a co-owner or beneficiary named, the co-owner or beneficiary is the new owner and as such is required to include on his or her return interest earned on the bonds for the year the bonds are redeemed or disposed of (including re-registration by substituting a new owner for the original living owner) or the bonds reach final maturity, whichever occurs first. Alternatively, even when there is a surviving co-owner or beneficiary, the person filing the decedent's final 1040 has the option of reporting on that return all interest earned on the bonds to the date of death. This option might be used where a person on a low income tax bracket has died, leaving the bonds to a person in a higher tax bracket.
The Bureau of Public Debt, on the Treasury Direct website, has detailed articles specifically outlining how savings bonds are to be treated in the event of the death of a bond holder.