Interest on certain U.S. savings bonds is excluded from income if 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 is straightforward.
Determining Eligibility Requirements
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 the owner bought the savings bond.
Savings bonds purchased to pay for a child’s education must be registered in the parent’s name, not the child’s. The child can be listed as a beneficiary on the savings bond but cannot be a co-owner. You are not required to list the beneficiary on the savings bonds.
If the child’s parent provided the funds for a child-owned savings bond, the savings bond can be reissued in the parent’s name:
- To reissue paper savings bonds, file form 4000E
- If the savings bonds were bought through TreasuryDirect using a minor-linked account, log in to the account and file form PD F 5446
- If you bought the savings bonds through TreasuryDirect and are not in a minor-linked account, you can log in 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.
You must redeem the savings bond to pay for qualified higher education expenses at an eligible institution or roll 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.
Meet Qualified Higher Education Expenses Requirements
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 tax-free interest is the redemption portion attributable to the adjusted qualified education expenses. Just multiply the total interest by the adjusted qualified education expenses ratio to the total proceeds.
Qualified higher education expenses include tuition and fees paid for a degree or certificate program at an eligible institution. The expenses must have been paid for by the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent.
Qualified college expenses do not include books, supplies, equipment, or room and board expenses.
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 all colleges and universities eligible for IV federal student aid.
Consider Income Phase-outs
For the 2024 tax year, the interest exclusion phases out for modified adjusted gross incomes (MAGI) ranging from $96,800 to $111,800 for single filers and from $145,200 to $175,200 for married couples 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 income phase-out. So, to avoid triggering the income phase-outs, one may need to use or roll over the savings bonds over several years.
Reporting 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:
- List the name of the plan beneficiary 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.
- 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, l st the name and address of the financial institution where the account is located.
- List the amount of the contributions on line 2.
- If you only contributed to a 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.
- Enter the amount of interest on line 1 of Schedule B, Interest and Ordinary Dividends, and the amount of the exclusion on line 3.
Benefits of a Savings Bond Rollover
Instead of spending the proceeds of a savings bond redemption on qualified higher education expenses, the taxpayer can roll over 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 plans have a broader set of qualified higher education expenses
Savings bonds are limited to tuition and fees. At the same time, you can use 529 plans 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 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 exceed the qualified higher education expenses in the same calendar year, part of the interest income will be taxable. This timing issue is not a problem with 529 college savings plans.
529 plan withdrawals are tax-free regardless of 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 Handle Grandparent-owned Savings Bonds
Typically, grandparents 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 savings 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.
- The grandparent should list themself as a beneficiary on the 529 college savings plan.
- The grandparent does not need to be the account owner of the 529 college savings plan.
- The grandparent redeems the savings bonds and contributes the proceeds to the 529 college savings plan within 60 days.
- 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 its three tests apply. There is no binding commitment to complete each step, and the sites are not mutually interdependent. The intention 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 themself.
References
You can obtain additional information from the following sources:
- Internal Revenue Code: 26 USC 135
- Chapter 10 of IRS Publication 970
- Using Savings Bonds for Education, FS Publication 0051, Bureau of the Fiscal Service, Department of the Treasury
