07 Apr Savings bonds, taxes and college payments

Q. What are the tax implications when you redeem savings bonds? I have heard that if you use them for a child’s education you don’t have to pay taxes on the gains. I have some that have matured and I want to use them toward my son’s college tuition. Do they have to be deposited in a special account to go towards the tuition? Or can I cash them out and put them in my regular savings account and when the tuition bill arrives just apply them (along with additional money), to pay the tuition. We don’t have a 529 plan now.
— Bills to pay

A. U.S. Savings Bonds are debt securities issued by the U.S. Department of the Treasury to help pay for the U.S. government’s borrowing needs.

U.S. Savings Bonds are considered one of the safest investments because they are backed by the full faith and credit of the U.S. government, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

One major benefits of holding U.S. Savings Bonds is that they are free of state income tax. The federal government does not tax state interest (municipal bond interest) and the states do not tax federal interest, Kiely said.

He said U.S. Savings Bonds do not pay periodic interest. Instead, it accrues over time.

“When you redeem savings bonds you collect the amount you paid for the bond plus all the interest that has accrued on the bond,” Kiely said. “Under certain circumstances, you can exclude the interest from your federal tax that is due if you use the bond proceeds to pay for college.”

Kiely said you can take the exclusion if all four of the following apply:

1. You cashed qualified U.S. savings bonds in 2016 that were issued after 1989.

2. You paid qualified higher education expenses in 2016 for yourself, your spouse, or your dependents.

3. Your filing status is any status except married filing separately.

4. Your modified AGI (adjusted gross income) is less than: $92,200 if single or head of household; $145,750 if married filing jointly or qualifying widow or widower with a dependent child.

You would exclude the interest from income by using IRS form 8815 “Exclusion of Interest From Series EE and I U.S. Savings Bonds issued after 1989,” Kiely said.

The IRS has some recordkeeping requirements that you must adhere to so you can verify the interest you exclude.

Kiely said you should keep bills, receipts, canceled checks, or other documents showing you paid qualified higher education expenses in 2016, plus a written record of each post-1989 series EE or I bond that you cash.

“Your record must include the serial number, issue date, face value, and total redemption proceeds (principal and interest) of each bond,” he said. “You can use Form 8818, “Optional Form to Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989,” as your written record.”

You don’t need a 529 plan to make any of this happen.

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This story was first posted in April 2016.