I Bonds for College Savings
If you’re a financial advisor, it’s hard to go an hour without talking about I Bonds right now. It seems the word is getting out to the general public now too.
I Bonds are a form of Treasury bond that pay an interest rate that incorporates an inflation factor. Right now, due to high inflation, they are paying 7.12% interest. Which compares pretty favorably to just about anything, especially your online savings account or other bond funds. And keep in mind: Treasury bonds are considered a risk-free investment because they are backed by the full faith and credit of the federal government. Your principal and interest are guaranteed.
Even better: I Bonds can be used to pay for college, with interest earned being tax-free if the bonds are used for Qualified Higher Education Expenses– tuition and fees, books, supplies, room and board– for eligible taxpayers. Eligibility is income-based and phases out started at MAGI of $123,550 for married filers and $82,350 for all others. Better still, you can use I Bonds for pretty much anything; if they’re not used for qualified higher education expenses, you simply pay federal– not state– income taxes on the interest accrued when you redeem the bond.
I Bonds aren’t a complete slam-dunk; as with any instrument receiving preferential tax treatment there are some rules.
You must hold the I Bond for at least 1 year. If you redeem it (cash it in) within less than 5 years, you’ll forfeit the last 3 months’ interest.
The interest rate on I Bonds resets every 6 months, at the end of April and end of October. Thus, the current 7.12% rate is only guaranteed through the end of April 2022. For reference, through Oct. 31, 2021, the interest rate was 3.56%– which is still light years above anything else out there.
You are limited to $10,000 of I Bonds purchases per calendar year, per Social Security number. That means that you could purchase $10,000 now and an additional $10,000 in January, and then no more until 2023. (Spouses can do the same.)
You can purchase additional I Bonds in your child’s name; however, only I Bonds issued in the parent’s name are eligible for tax-free distributions for QHEEs.
If your income goes over the limit for interest deductibility, all the accrued interest will be taxable when you redeem the bond. However, you can roll I Bonds tax-free into your 529 account as long as you’re under the income threshold– something to plan for as your income grows. This allows you to continue receiving tax-free treatment.
I Bonds can be a great choice even if your income is above the threshold for it to be tax-free. We recommend them as a general savings vehicle as appropriate, noting the restrictions on use in the first year. What’s more, parents looking for a way to save for non-qualified education costs– transportation, personal expenses, etc.– might find these to be a great complement to their 529 plan even without tax benefits. Just watch out for the income generated when you redeem them: all interest accrues in the account and becomes taxable income when you redeem the bond.
You can buy I Bonds online at Treasury Direct.
