Dear Dr. Don,
I have a question about Series EE savings bonds. I purchased them through my employer when my children were born. In doing so, we were told these could be used for education and then would be tax-free.
When I purchased the bonds, they were in my name and payable on death in each of my children's names. I wanted to cash them in to put into a 529 plan. College is here for both (of) my children.
I have been advised (that), because my name is on them, I would have to pay the taxes. I thought if I used them for education they were tax-free. How do I use these for college expenses and avoid paying the taxes?
-- Jody Junior
You did the right thing by having the savings bonds registered in your name, not your children's. Savings bonds purchased after 1989 can, if you qualify, be used in the Education Savings Bond Program.
To qualify, you need to have been at least 24 years old by the bond's issue date, which for paper bonds is printed on the front of the bond. You also have to meet the modified adjusted gross income, or MAGI, limitations in the year the bond is redeemed to pay for qualified education expenses.
The TreasuryDirect Web site explains this program in greater detail on its "Education Planning" Web page, and the IRS provides the updated MAGI limitations for the 2009 tax year on its "Education Savings Bond Exclusion" page. The limitations are shown below:
For 2009, the amount of your interest exclusion is phased out (gradually reduced) if your filing status is married filing jointly or qualifying widow(er) and your modified adjusted gross income (AGI) is between $104,900 and $134,900. You cannot take the exclusion if your modified AGI is $134,900 or more.
For all other filing statuses, your interest exclusion is phased out if your modified AGI is between $69,950 and $84,950. You cannot take the exclusion if your modified AGI is $84,950 or more. For more information, see chapter 10 in Publication 970, "Tax Benefits for Education."
Selling the savings bonds to fund a Section 529 college savings plan can be a qualified educational expense, but if you qualify for the Education Savings Bond Program, you don't need the tax benefits of the 529 account -- you'll get the benefits from the bond program. Since your children are college age, you don't have the need to redeem the bonds into the 529 account.
If you don't qualify, you can't redeem the savings bonds to fund a 529 account to finesse the issue of not qualifying. You'll owe income taxes on the interest earnings. You should talk to your tax professional to see if he or she has any ideas on minimizing the tax impact of these redemptions.
Read more Dr. Don columns for additional personal finance advice.