Do you have any savings bonds? Those old paper bonds that some of our grandparents got us when we were born to help pay for college could be worth big bucks today.
If you’re in college or plan to go to graduate school, you can use those savings bonds to avoid bigger student loans. Read on to find out how to use Series EE savings bonds for education tax-free, or how you can cash them in to pay your student loans.
What is a savings bond?
A savings bond is a tool used to loan a small amount of money to the government in exchange for interest. The first savings bonds were issued in 1935 after President Franklin D. Roosevelt signed a law authorizing the US Department of the Treasury to issue a new type of savings security: the savings bond.
The first savings bonds were issued to help fund the United States’ involvement in World War II, and were issued as “defensive bonds.” After the war ended, many Americans held their bonds so they would grow in value before cashing them in.
The Treasury Department currently issues Series EE bonds and Series I bonds. They are very similar but have some important differences in how they earn interest. For the rest of this article, we will focus on Series EE savings bonds.
Series EE savings bonds are sold at face value and earn a little bit of interest each month. While the interest rate is low and set at the time the bond is issued, the bonds are virtually risk-free.
The Treasury guarantees that the bond’s value will double 20 years after issue, at which point the interest rate resets to current interest rates for another ten years. After 30 years, the bonds stop earning interest.
For example, if you pay $100 for a Series EE savings bond in 2016, it would be worth at least $200 in 2036. This is why they are so popular as a gift to young children from older relatives. If Mom and Dad keep the savings bonds safely tucked away until college, those savings bonds can cover a portion of the cost of education that is worth about double what was paid.
Savings bonds are issued in any denomination above $25. People can buy up to $10,000 per series in electronic savings bonds per year.
Through 2012, savings bonds could be purchased through banks, but now they can only be purchased online through TreasuryDirect. Existing savings bonds can be redeemed through a bank or TreasuryDirect.
How to use Series EE savings bonds for education tax-free
Interest on Series EE savings bonds is taxable on your federal tax return, but not at the state or local level. Through 1989 that was the rule across the board, but Series EE savings bonds purchased on or after January 1, 1990 have different rules when it comes to using your savings bonds to pay for education.
Congress created the Education Savings Bond program starting in 1990. Now all savings bonds issued on or after January 1, 1990 can be redeemed for qualified education expenses tax-free!
What education expenses qualify
Let’s say you are a college student enrolled at a major university or trade school. If the school is qualified for federal student loan programs like Stafford and Perkins loans, you are eligible to cash in your savings bonds tax-free. The Perkins Loan program was closed to new borrowers when it expired on Sept. 30, 2017.
Loan proceeds must be used for tuition and fees directly related to your degree program. The funds cannot be used for books, room and board, or other extra-curricular activities like clubs and fraternity dues.
If you cash in savings bonds in a single calendar year that have accrued more interest than you need (only interest is taxed, not the original principal), any excess interest is taxable.
For example, if you redeem savings bonds that have earned $10,000 in interest and your tuition and fees were $9,500 that calendar year, you would pay income tax on the remaining $500.
If you have any doubt on how to handle your taxes, contact a qualified tax expert.
Why you may want to keep those bond a while longer
If your savings bonds are less than 30 years old, they’re still earning interest. If that’s the case, you don’t have to cash them in. Keep on earning that interest!
If you have college tuition and fees in your future, you can keep those bonds until you incur the qualified education expense and redeem the bonds in those years to keep your tax bill as low as possible.
If your bonds are more than 30 years old, you are typically best off cashing them in and investing the proceeds, unless you are in a unique tax situation where that would not be beneficial. Again, talk to a qualified tax expert if you are not sure.
If you are somewhere in the middle (your bonds are still earning interest but don’t qualify for the tax-exemption or you don’t have education expenses in the foreseeable future), you’re in a gray area. If you are done with school and have student loans, you can cash in your savings bonds to help pay off your student loans.
Just remember that you’ll have to pay taxes on your bond’s interest, so put some cash aside to avoid surprises you can’t afford on tax day.
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