Education Savings Bonds

Over two decades ago, the United States Treasury Department introduced their Education Bond Program. How does this program differ from just buying savings bonds for your kids? Actually there is more to this program than just a fancy name for buying bonds for a specific purpose in mind. The Education Bond Program excludes bond interest, completely or in part, from federal income tax, if the bond owner pays for qualified higher education expenses at an eligible institution or a state tuition plan in the year that the bonds are redeemed. Sound interesting? Let's look at how the program works.

Eligibility requirements. Series EE or Series I bonds issued after 1989 are eligible, and you don't have to specify that you're going to use the bonds for educational purposes when you purchase them. That being said, the requirements you must meet to be eligible for the program are as follows:

• You must be at least 24 years old on the first day of the month in which you purchase the bonds.
• If you are using the bonds for your own education, they must be registered in your name.
• If you're using the bonds for your child's education, the bonds must be registered in your name and/or your spouse's name.
• Spouses must file a joint return to qualify for the interest tax exclusion.
• Qualified educational expenses must be incurred in the same year that the bonds are redeemed.

Warning Your child cannot be named as a co-owner in order for the bonds to qualify for the program. However, it's OK if your child is listed as a beneficiary on the bond.

Eligible institutions and qualified expenses. You have to use both the principal and the interest from the bonds to pay qualified expenses if you want to exclude the interest from federal income tax. Also, if the qualified educational expenses paid during the year you cashed in your bonds are less than proceeds from your bonds for that year, the amount of interest you exclude from income tax is reduced on a pro rata basis. See our discussion of the tax rules relating to the treatment of Series EE bonds used for education.

Last, but certainly not least, what exactly are eligible institutions and qualified educational expenses for purposes of this program? Eligible institutions are colleges, universities, vocational schools and other post-secondary institutions that qualify for federal government assistance, i.e., financial aid. As for qualified educational expenses, they include tuition, fees and amounts paid for any course involving sports, games, or hobbies, but only if they are required to get a degree or certificate from a program. Unfortunately, room and board and books are not considered qualified educational expenses for education bond purposes. However, remember payments to state tuition plans are considered qualified educational expenses. Finally, other forms of tuition reduction, including tax credits, scholarships, fellowships, or employer-provided educational assistance can reduce the amount of qualified educational expenses.

Advantages and disadvantages of the program. Assuming you fulfill all the requirements, should you use the Education Bond Program as an education investment vehicle? Well, the advantage of this program is that the interest earned is totally or partially excluded from tax when the bonds are redeemed. Now, let's get into the disadvantages of this program. Number one on that list is the low rate of return on these savings bonds. It's true that this type of investment is very low-risk, but so are other types of bonds where you can do better on the interest earned. Due to the high cost of education, this type of program may not be aggressive enough for many families. Also, if your child decides not to go to college, or if your income goes beyond the allowable limits for receiving the tax deduction when you cash in the bonds, you're going to have to pay tax on the bond proceeds. Don't forget too, that the income limitations for this program are based on a modified adjusted gross income figure that includes the interest earned on the savings bonds you are redeeming.

You can get the latest information on savings bond interest rates and buy savings bonds online by going to the Treasury Department website.

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