Using I Bonds to Pay for College
Buying I Bonds was a smart move back when they were paying 9%. But with interest rates much lower now, they might feel more like a high yield savings account with extra hassles attached. Good news: you can use your I Bonds to pay for college-- and like a 529 distribution, the interest could be tax-free. You have a couple of good options for doing so.
Option 1: Redeem I Bonds and pay tuition directly to the school
Interest from U.S. savings bonds (including I Bonds) can be tax-free when used for qualified higher education expenses under the Education Savings Bond Program.
That means if you redeem the bonds and use the proceeds for tuition and required fees in the same calendar year, you may be able to exclude the interest from federal income tax.
But there is an important limit: Qualified expenses are narrower than 529 qualified expenses-- tuition and required fees only, not room and board or books, and only for an undergraduate student. Which leads us to:
Option 2: Redeem I Bonds and roll them into your 529
You can redeem I Bonds and contribute the proceeds to a 529 in the same calendar year and still qualify for the federal tax exclusion on the interest. In other words, instead of paying tuition directly from the bonds, you can move the money into a 529 and keep all the flexibility that comes with it.
Rolling your I Bonds into your 529 has several benefits:
You can use them for anything that's a qualified use for a 529: besides tuition, room and board, books, supplies, a computer and more are eligible 529 expenses.
If your student is still a ways from college, you can invest the proceeds for growth in the 529. I Bonds are designed as a hedge against inflation-- specifically, inflation in consumer prices, not college prices. Your 529's investment options, especially age-based or target-enrollment portfolios, are designed to help your money grow to cover inflation in college costs.
529s can be used for graduate school.
The broader range of qualified 529 expenses allows for better coordination with scholarships and the American Opportunity Tax Credit.
You might be able to claim a state income tax deduction or credit for the rollover.
There are some rules and fine print around either strategy:
The tuition payment or 529 rollover must occur in the same calendar year as the I Bonds are redeemed-- which is a good reason to think about this now, rather than waiting until December.
Income limits apply to tax-free rollovers. If you file single or head of household, the tax exclusion begins to phase out at a MAGI of $101,800 and is completely eliminated at $116,800. Married filing joint, the tax exclusion begins to phase out at a MAGI of $152,650 and is completely eliminated at $182,650.
The I Bonds must be owned by the parent (or grandparent as applicable).
You'll need file IRS Form 8815 to claim the interest exclusion on your taxes.
I Bonds are a great savings tool, but if you still own them it's worth asking if they're in the right place.
If you found this helpful, you’ll want to grab a copy of my book, How to Pay for College. It’s packed with strategies to get a great education at a price that works for your family.
