Dear Dr. Don,
We purchased Series EE savings bonds for our son’s education in 1990. When it came time for college, however, he used an ROTC scholarship to finance his college expenses.
Our son (26) is now enrolled in a master’s program. We also have and are currently purchasing Series I savings bonds in my name that are payable on death to my son.
Can we redeem these EE U.S. savings bonds now and pay for this program? Or should we give him the Series I U.S. savings bonds? If so, can he avoid paying taxes on the bonds?
— Shyrl Savings
Your son must be a dependent for you to be eligible to take advantage of the education tax exclusion for the master’s program. Qualified educational expenses are defined, in part, on the TreasuryDirect Education Planning Web page as “expenses that benefit you, your spouse or a dependent for whom you claim an exemption.”
The bonds also have to be registered in the parent’s name to take advantage of the tax exclusion. Your child can be listed as a beneficiary (payable on death, or POD) on the bond, but not as a co-owner.
If the bonds are registered in your name, and assuming you meet the income and other requirements for the education tax exclusion — also identified on the “Educational Planning” Web page — you can redeem the savings bonds and use them to pay qualified education expenses for the graduate program. The page also spells out what does and does not count as a qualified education expense.
If you don’t have your savings bond portfolio listed in a file using the Treasury’s Savings Bond Wizard, I suggest you take that step. This will give you a better handle on what the bonds have earned in interest, and the average yield and current yield on each bond.
The advantage of the education tax exclusion is to keep the accumulated interest free of federal income taxes. Cashing in recently purchased savings bonds won’t give you much bang for the buck.
Also, savings bonds have a one-year minimum holding period and an early redemption penalty of the last three months’ interest if the savings bond is redeemed in the first five years of ownership.
If you don’t qualify for the education tax exclusion, you have to trade off the tax impact of cashing in a 20-year-old bond and its yield versus redeeming inflation-indexed Series I savings bonds. Make sure you don’t redeem an older bond before its next interest payment date, which is spelled out on the Savings Bond Wizard.
If you redeem the bonds and use the proceeds to pay the tuition bill yourself to a qualifying educational organization, the tuition expense doesn’t count toward the annual exclusion for gift tax purposes.
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