Are U.S. Savings Bonds still an effective way to save for college?

http://www.savingforcollege.com/articles/are-us-savings-bonds-still-an-effective-way-to-save-for-college-759

Back in the dark ages before smartphones, Netflix and Facebook, U.S. Savings Bonds were the vehicle of choice for many families saving for college. Why? Well, for starters they offer guaranteed interest if held to maturity. And thanks to the Education Savings Bond Program, Series EE and I bonds purchased after 1989 by someone age 24 or older may be redeemed tax-free when the proceeds are used to pay for higher education expenses. This includes contributions to Coverdell Education Savings Accounts and 529 plans.

So what’s changed? Many families and financial professionals are realizing that 529 college savings plans might have more to offer. In 2006, the coveted federal tax benefits of 529 plans became permanent and they have been growing in popularity ever since. Today, there are over 100 different plans available that offer a variety of investment options. In most cases, a 529 plan is the best choice for college savings, but do U.S. Savings Bonds ever still make sense? Here are some things to consider:

Your household income
The tax exclusion on Series EE and I savings bonds is phased out for individuals with a modified adjusted income (MAGI) between $76,000 and $91,000 ($113,950 and $143,950 for married couples filing jointly). That means if your MAGI is higher than $76,000 you will have to pay taxes on part of the interest earned, and if you make more than $91,000 you won’t qualify for any tax break. 529 plans, on the other hand, offer tax-free earnings growth and tax-free withdrawals for families of all income levels who use the funds to pay for college. Some states also offer additional tax benefits for residents.

Maturity dates
Have you been holding on to savings bonds for as long as you can remember? Series EE savings bonds generally stop paying interest after 30 years. That means if your bond was purchased before 1985 there’s really no additional benefit to keeping it. But most parents saving for college today wouldn’t have a bond that old – so what should they do? Well, that all depends on the bond’s interest rate.

Interest rates
The amount of interest your bonds earn depends on when they were purchased. Families who purchased savings bonds issued between May 2006 and November 2006 are enjoying a 3.7 percent guaranteed interest rate. However, rates have been much lower in recent years. It’s a good idea to compare your bond’s interest rate with the potential return you would receive from a 529 plan. In today’s low interest rate environment, the 529 plan return will likely come out ahead.

Financial aid
To be eligible for the tax breaks on Series EE and I bonds, the proceeds must be spent on college related expenses for the bond owner, their spouse or their dependent. The bonds are considered an asset on the Free Application for Federal Student Aid (FAFSA), but their value can have a very different affect on the student’s eligibility for aid depending on the owner. If the parent owns the bond, it will be considered a parental asset when calculating the Expected Family Contribution (EFC) and can reduce the amount of aid you are eligible for by a maximum of 5.64 percent of it’s value. However, if the student owns the bond, its value will be assessed at 20 percent. That means if you have bonds in your child’s name worth $10,000, the amount of aid they are eligible for will be reduced by $2,000, but if the bond is in your name the maximum impact is only $564.

Funds saved in a parent- or student-owned 529 plan, however, are always counted as parental assets on the FAFSA. If the student was at least 24 years old when the bond was purchased, you can redeem it tax-free and deposit the proceeds into a 529 plan to take advantage of the more favorable financial aid treatment.

Savings bonds aren’t the only low-risk option
When you save with a 529 plan, your money is invested into mutual funds or other similar investments. When you enroll in a plan, you’ll have to select your investment option based on your appetite for risk. Some plans offer low-risk FDIC-Insured options, where the investments are backed by the full faith and credit of the U.S government up to certain limits in the event of a bank failure. If you’re thinking about moving your college savings from savings bonds to a 529 plan but are worried about the added risk, a plan that offers FDIC-insured options might be a good fit.