How to Rollover U.S. Savings Bonds into a 529 Plan

Mark KantrowitzBy Mark KantrowitzBy Savingforcollege.com

Interest on certain U.S. savings bonds is excluded from income if the savings bonds are used to pay for qualified higher education expenses or rolled over into a 529 college savings plan, prepaid tuition plan or Coverdell education savings account. The process for reporting a savings bond rollover can be a little confusing, but nevertheless is straightforward.

Eligibility Requirements

The Education Savings Bond Program provides an income exclusion for interest on certain U.S. savings bonds when the proceeds are used to pay for college or rolled over into a 529 college savings plan or Coverdell education savings account.

The interest exclusion applies to Series EE Savings Bonds issued in 1990 or a later year and all Series I Savings Bonds. Other types of savings bonds are not eligible. These savings bonds can earn interest for up to 30 years.

The savings bond owner must have reached age 24 before the bond issue date, which is the first day of the month in which the savings bond was bought.

Savings bonds that are purchased to pay for a child’s education must be registered in the parent’s name, not the child’s name. The child can be listed as a beneficiary on the savings bond, but cannot be a co-owner of the savings bond. The child is not required to be listed as a beneficiary on the savings bonds.

If the funds for a child-owned savings bond were provided by the child’s parent, the savings bond can be reissued in the parent’s name:

  • To reissue paper savings bonds, file form PD F 4000 E
  • If the savings bonds were bought through TreasuryDirect using a minor-linked account, login to the account and file form PD F 5446
  • If the savings bonds were bought through TreasuryDirect and are not in a minor-linked account, the parents can login to the account and correct the savings bond registration directly

Bonds purchased for the taxpayer’s own education must be registered in the taxpayer’s name.

The savings bonds must be redeemed to pay for qualified higher education expenses at an eligible institution or rolled over into a Qualified Tuition Plan (QTP) or a Coverdell education savings account. Qualified Tuition Plans include 529 college savings plans and prepaid tuition plans. Rollovers must occur within 60 days of redemption.


Qualified Higher Education Expenses

If the total proceeds from redeeming eligible U.S. savings bonds is less than or equal to the adjusted qualified education expenses, then the savings bond interest is entirely tax-free. Otherwise, the portion of the interest that is tax-free is the portion of the redemption that is attributable to the adjusted qualified education expenses. Just multiply the total interest by the ratio of the adjusted qualified education expenses to the total proceeds.

Qualified higher education expenses include tuition and fees paid as part of a degree or certificate program at an eligible institution. The expenses must have been paid for the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent.

Qualified higher education expenses do not include expenses for books, supplies and equipment or room and board.

Qualified higher education expenses are reduced by the amount of any tax-free educational assistance that depends on tuition and fees, such as scholarships, the American Opportunity Tax Credit (AOTC), veteran’s education assistance, employer-paid educational assistance and tax-free distributions from 529 plans. This yields the adjusted qualified education expenses.

The expenses must occur in the same year as the bond redemption.

Eligible institutions include colleges and universities that are eligible for Title IV federal student aid.


Income Phase-outs

The interest exclusion phases out for 2018 income (MAGI) between $79,550 and $94,550 for single filers and between $119,300 and $149,300 for taxpayers who file as married filing jointly. Married taxpayers who file as married filing separately are ineligible.

The income phase-outs are adjusted annually for inflation and are rounded to the nearest multiple of $50.

Note that when a savings bond is redeemed, the interest counts as income for the purpose of the income phase-out. So, one may need to use or rollover the savings bonds over several years to avoid triggering the income phase-outs.

Benefits of a Savings Bond Rollover

Instead of spending the proceeds of a savings bond redemption on qualified higher education expenses, the taxpayer can rollover the funds to a 529 college savings plan, prepaid tuition plan or Coverdell education savings account.

There are several benefits to rolling over savings bonds into a 529 college savings plan:

  • 529 college savings plans have a broader set of qualified higher education expenses. Savings bonds are limited to tuition and fees, while 529 plans can be used to pay for textbooks, supplies and equipment, computer equipment, peripherals, software and internet access, special needs expenses, and room and board (if enrolled at least half-time), as well as tuition and fees.

  • 529 college savings plans do not have income phase-outs. Taxpayers can bypass the income phase-outs on savings bonds by rolling them over into a 529 college savings plan before their income increases beyond the income phase-outs.

  • 529 plans provide more control over distributions. If the proceeds of a savings bond redemption exceeds the qualified higher education expenses in the same year, part of the interest income will be taxable. This timing issue is not a problem with 529 college savings plans.

  • The tax-free status of distributions from 529 college savings plans does not depend on the taxpayer’s federal income tax filing status. The interest on a savings bond is taxable if the taxpayer files federal income tax returns as married filing separately. Qualified distributions from a 529 plan are tax-free regardless of the taxpayer’s tax filing status.

How to Report a Savings Bond Rollover to the IRS

A savings bond rollover is reported on IRS Form 8815 to exclude the savings bond interest from income. (IRS Form 8818 can be used to record the redemption of U.S. savings bonds to comply with the IRS recordkeeping requirements.)

This form is confusing, since it refers only to qualified higher education expenses. It does not seem to consider the possibility of a rollover into a 529 plan or other college savings account.

To report a savings bond rollover, follow these steps:

  1. List the name of the beneficiary of the college savings plan account on line 1, column (a). The beneficiary must be the taxpayer, the taxpayer’s spouse or a dependent of the taxpayer. The dependent must be claimed on the taxpayer’s federal income tax return.
  2. Enter “QTP” on line 1, column (b), if the savings bond proceeds were contributed to a 529 college savings plan or prepaid tuition plan. Enter “Coverdell ESA” if the proceeds were contributed to a Coverdell education savings account. Also, list the name and address of the financial institution where the account is located.
  3. List the amount of the contributions on line 2.
  4. If you were only contributing the funds to a 529 college savings plan, prepaid tuition plan or Coverdell education savings account, there should be no offsetting tax-free education benefits. Write a zero on line 3.
  5. Enter the amount of interest on line 1 of Schedule B, Interest and Ordinary Dividends, and the amount of the exclusion on line 3.

How to Handle Grandparent-owned Savings Bonds

Normally, a grandparent can claim the interest exclusion for a grandchild only if the grandchild is claimed on the grandparent’s tax return.

The tax-free redemptions are limited to the taxpayer, the taxpayer’s spouse and the taxpayer’s dependents.

You can’t change the bond owner to be the grandchild’s parents, as you’d have to pay income taxes on the saving bond’s interest. Changing the bond owner might also be subject to gift taxes.

There is a multi-step workaround when the grandchild is not a dependent of the grandparent.

  1. The grandparent should list himself or herself as a beneficiary on the 529 college savings plan.
  2. The grandparent does not need to be the account owner of the 529 college savings plan.
  3. The grandparent redeems the savings bonds and contributes the proceeds to the 529 college savings plan within 60 days.
  4. The beneficiary of the 529 plan is changed from the grandparent to the grandchild.

This process does not violate the step transaction doctrine because none of the three tests of the step transaction doctrine applies. There is no binding commitment to complete each step. The steps are not mutually interdependent. The intent of each step could have an independent purpose. For example, the grandparent could choose to use the 529 plan funds to pay for continuing education courses for himself or herself.


References

Additional information may be obtained from the following sources:


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