Why Retiring Military Officers May Need to Cash US Savings Bonds Now

Tax Free Benefit May Be Lost After Military Retirement

A lot of military officers buy US Savings Bonds.  The government makes it pretty easy for you to do so and when I was a lieutenant (shortly after the earth cooled) we were "encouraged" to purchase Savings Bonds.  I had some.

One way you can use the Savings Bonds is to pay for qualified education expenses for your children.  If you do, the interest accrued on those bonds will be tax free.  Unless, along with some other rules...

Tax Free Benefit Phases Out

If your income is above certain limits, which are adjusted for inflation, you lose the tax-free benefit.  In 2018, the benefit is eliminated at $149,300 of Adjusted Gross Income (AGI) for those who file jointly or as a qualifying widow(er).  For all others, the benefit is eliminated at $93,150.  The benefits start to phase out at $119,300 and $79,550 respectively.

If you're an O-6 you are most likely already in the phase out range.  If you're an O-5 or O-4, that probably won't be the case.

Once you retire, your combined military retirement income and new employment income will likely put you over the AGI limit.

What Retiring Military Officers Can Do

If you have children currently in college, cash the bonds now (prior to year of retirement) and enjoy the tax-free benefit or portion thereof.  Be careful though if you're using the GI Bill at an in-state school and all qualified tuition and fees are covered. If that is the case, the interest on the bonds will become taxable.

What if the children are nowhere near college age?  There is a solution.  Contributions to a 529 plan are considered "qualified education expenses".  If you cash the bonds and roll the proceeds to a 529 plan, you preserve the tax-free nature of the interest. As long as you use the 529 funds for qualified expenses, you won't have to pay taxes on the Savings Bonds proceeds.  Conversely, if you take the funds out and don't use them on qualified expenses, you will not only owe taxes but you'll owe a 10% penalty on the proceeds (which you wouldn't have owed if you just cashed the bonds).

Military Finances are Different

Most Americans don't start receiving a pension in their 40's or 50's and most financial advisors aren't used to working with those who do.  If you decide you want some help with your finances, make sure you work with someone who understands your benefits and how your finances are different from civilians.