Can You Cash in Savings Bonds and Invest Them for a Child's Education?

by Herb Kirchhoff

The Internal Revenue Service allows you to cash in your U.S. savings bonds to pay educational expenses without owing income tax on the interest, if you meet certain qualifications, including age and income requirements. You can use bond proceeds for your own education or that of a dependent child, subject to certain qualifications.

Not an Option

You don't get the education tax exemption if you cash in your savings bonds so you can invest the proceeds in some other type of education savings plan for your child. There's no rule against cashing in your savings bonds to reinvest the proceeds in something else, but all your bond interest will be fully taxable. You also would forfeit three months interest if the bonds were less than five years old. Your principal, of course, is not taxed since you paid the taxes on that money before you bought your bonds.

Qualifying Expenses

You get the education tax exemption if you spend bond proceeds on tuition and related fees and expenses for courses that lead to a degree or certificate for your child or yourself from an accredited college, university or vocational school. You must spend the bond proceeds on qualifying education expenses in the same year you redeemed your bonds. Expenses for sports, games or hobbies don't qualify unless they are a required part of course work. Expenses for books or for room and board also don't qualify. Qualified expenses are reduced by the amount of any scholarships, grants, fellowships, employer subsidies or other forms of tuition assistance.

Prorated Tax

You must spend both the principal and interest from your redeemed bonds on qualifying educational expenses for yourself or your child. If your redemption proceeds exceeded your education expenses, the tax-exempt interest is prorated. For instance, if you received $10,000 from your bonds comprised of $8,000 in principal and $2,000 in interest, and you spent $10,000 on qualifying educational expenses, all your interest would be tax-free. But if you spent only $8,000 (80 percent of the total proceeds) on education expenses, you would get the tax exemption on only 80 percent of the interest, or $1,600. The other $400 would be taxable interest to you.

Qualifications

The savings bond tax exemption for education is linked to your age and income. You must be over age 24 to get it. If single, you must have earned less than $70,100 to get the full exemption. The tax break phases out for incomes between $70,100 and $85,100. There's no education tax exemption if income exceeds $85,100. Married couples filing jointly get the full exemption if combined income is below $105,100. The exemption is phased out above that income level and disappears entirely at $135,100. Also, the bonds you redeem must be in your name and/or your spouse's name, and if the proceeds are used for a child's education the child must be claimed as your dependent.

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