Savings Bonds: A Safe and Tax-Advantaged Route to Education Funding

Savings bonds, particularly Series EE and Series I, offer a unique avenue for funding education, combining safety with potential tax benefits. While 529 college savings plans have gained popularity, savings bonds present certain advantages, especially for risk-averse investors. This article delves into the uses and benefits of savings bonds for education, exploring their features, tax implications, and how they compare to other college savings options.

Understanding Savings Bonds: Series EE and Series I

Savings bonds are appreciation-type savings securities, meaning they are sold at face value. You pay $50 for a $50 bond, and it's worth its full value upon redemption. Since January 1, 2012, paper savings bonds are no longer available at financial institutions. Instead, you can purchase electronic savings bonds through TreasuryDirect.

Series EE bonds earn a fixed rate of interest, set when you buy the bond, for the first 20 years. Interest is compounded semiannually, meaning that every 6 months the bond’s interest rate is applied to a new principal, which is the sum of the prior principal and the interest earned in the previous 6 months. New EE bonds are electronic only, requiring a TreasuryDirect account for purchase and management. Some paper EE bonds sold between 2001 and 2011 bear the inscription "Patriot Bond," a special edition to fund anti-terrorism efforts.

Series I bonds offer a fixed rate of interest adjusted for inflation. They earn interest in two ways: a fixed interest rate and a variable rate that adjusts to the level of inflation every six months. Series I bonds are often a popular investment when inflation rises.

Key Features and Purchase Details

Minimum Purchase: $25 or any amount above that to the penny. You can buy these electronic savings bonds in penny increments, from $25 up to $5,000 each year.
Maximum Purchase: In any one calendar year for one Social Security Number, you may buy up to $10,000 in EE bonds or $10,000 in Series I bonds. Up to $5,000 more in Series I bonds can be purchased with a tax refund.
Interest Accrual: Your EE and I savings bonds earn interest from the first month you own them.
Redemption: If you redeem the bonds in the first five years of buying them, you’ll forfeit interest payments for the three most recent months. For a paper bond, interest is paid when you cash the bond or when the bond finishes its 30-year life (it matures).

Tax Advantages for Education

One of the significant benefits of Series EE and Series I savings bonds is the potential for tax advantages when used for qualified education expenses. Here's a breakdown:

Read also: Future College Planning Guide

Federal Tax: You pay no state or local taxes on the interest on the bonds, and you can defer paying federal taxes on the interest until you cash in the bond or until it matures. Normally, the interest you earn on your savings bonds becomes part of your gross income for tax purposes. However, under an education savings bond program, you may be able to exclude the interest from your income. The interest is issued electronically to your designated account.
State and Local Tax: Bonds are not taxable at the state level.

Requirements for the Education Tax Exclusion

To qualify for the education tax exclusion, you must meet specific requirements set by the IRS:

Ownership: They must be registered with you as the owner, or in your name and your spouse’s name if married. The owner of the bond must be 24 years or older when the bond is issued. Therefore, a bond registered with a child as owner will not qualify even years later when the child is ready for college.
Income Limitations: Your modified adjusted gross income (MAGI) is less than the cut-off amount that the IRS sets for the year in which you want to take the exclusion. The cut-off amount may change each year.
- For 2024, the exclusion for Series I and EE bond interest begins phasing out at $96,800 for single filers, heads of household or qualifying surviving spouses, and ends at $111,800. For married couples filing jointly, the range starts at $145,200 and ends at $175,200.
- Savings bond interest deduction is subject to an income-based phase-out.
- Ranges are adjusted annually for inflation.
Qualified Expenses: You paid qualified higher education expenses to an eligible institution that same tax year. Such expenses include tuition, fees, student activity fees and related expenses required for enrollment at an eligible institution.
Age Requirement: The taxpayer must have been age 24 or older when the bonds were issued.
IRS Form 8815: IRS Form 8815 gives details and instructions.

Tax Implications

Form 1099-INT: You get a Form 1099-INT for the year in which you get the interest. The 1099-INT will include all the interest the bond earned over its lifetime. You may choose to report the interest every year, but you are not required to. The 1099-INT will only come when someone cashes the bond or the bond matures.
Reporting Interest: If you choose to report the interest every year on savings bonds in a child's name, you will not get a 1099-INT every year. When you get the 1099-INT at the end, it will show all the interest the bond earned over the years.
Tax Reduction: A household with modified AGI between $77,550 and $92,550, eligible for any credits or is subject to the alternative minimum tax (AMT), will experience a tax reduction of $500 at the federal level and $267 at the state level.

Savings Bonds vs. 529 Plans: A Comparison

While savings bonds offer safety and potential tax advantages, 529 college savings plans have emerged as a more popular college savings investment tool for several reasons.

529 Plans:

Growth Potential: They offer growth for college savings on a federal tax-free basis if used for what are known as qualified educational expenses - tuition and books, for example - and an array of investment options.
Higher Returns: Over a seven- or nine-year period, you should get rate of return of 5 percent at least with 529 plans.
Flexibility: 529 plans offer a wide variety of investment options, allowing you to tailor your portfolio to your risk tolerance and time horizon.

Savings Bonds:

Safety: Savings bonds are a government-guaranteed, safe, low-risk investment.
Lower Returns: The interest rate on a Series EE bond is a paltry 0.1 percent, meaning if you invest $100, you earn one penny each year. However, the Treasury guarantees that for an electronic EE bond with a June 2003 or later issue date, after 20 years, the redemption value will be at least twice the purchase price of the bond. That means a $10,000 bond bought today would be worth $20,000 if the owner held it until 2037, earning the equivalent of about 3.5 percent a year.
Tax Advantages: Offer tax benefits for higher education if owners meet certain requirements.

When to Consider Savings Bonds

Despite the higher growth potential of 529 plans, savings bonds can still be a valuable component of a college savings strategy in specific situations:

Risk Aversion: With savings bonds, owners will have little fear of losing their principal investment. If you aren't satisfied by the 529 plan's conservative options, a parent could consider including savings bonds as an element of a college savings strategy. They may serve as an effective complement to investments in a 529 account that may have more potential risk and reward.
Inflation Hedge: Series I bonds may be an attractive option, at least while they’re yielding a high rate, for saving for college. Series I bonds are often a popular investment when inflation rises.
Older Bonds: If you purchased a savings bond in the 1980s or 1990s, when interest rates were more competitive, you may want to hang on to your savings bonds to full maturity. If you bought in the '90s, there could be 7 or 8 percent interest on those things. You really wouldn't want to cash them out if you don't have to.
Tax Benefits: If you are holding a savings bond that you purchased after 1989 and think you may exceed the income limitations, cash it out and rolling it into a 529, where you could still get favorable tax treatment. You have 60 days to do so, but make sure you also fill out IRS form 8815 "to qualify you did not take money and run".

Cautions Regarding Series I Bonds

No federal tax protection unless used for education: You’ll lose the federal tax exclusion of your Series I bonds if they’re not used for educational purposes.
Yield may adjust lower: The Series I bonds offer a solid yield now, but that yield declines as inflation falls, especially given the Fed’s recent rate cut.
May not yield and compound well over time: A continued decline in yields is likely to happen as the Fed works to hit its 2 percent inflation target.
Lower current yield than a well-diversified portfolio of stocks: Yields on Series I bonds tend to be higher in times of elevated inflation, but are generally still lower than the long-term return on the Standard & Poor’s 500 index, a collection of hundreds of America’s top companies.

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