Families with savings bonds can avoid taxes by establishing a 529 plan

Families with savings bonds can avoid taxes by establishing a 529 plan

Generally, owners of certain government savings bonds have to pay taxes on interest — either in the year the interest was earned or when the bond is redeemed. Certain bond owners may be able to avoid taxes on all or a portion of the bond interest payments if the proceeds are designated for qualified education expenses. To be eligible for the interest exclusion, taxpayers must not exceed certain income limits (2010 tax year figures):

Filing status Modified Adjusted Gross Income (MAGI)
Single Interest exclusion is phased out if income is between $70,100 and $85,100
Joint Interest exclusion is phased out if income is between $105,100 and $135,100

Qualified U.S. Savings Bonds include a series EE bond issued after 1989 or a series I bond, and the owner must be at least 24 years old before the bond’s issue date.

While some families may be aware that these bonds can be utilized tax free for current college expenses, many may not realize that contributions to a qualified tuition plan (i.e., a 529 plan) are also eligible for the tax-free treatment. The bond owner would cash out the bond and direct the proceeds to establish a 529 account. In order to claim the income tax exclusion of the bond interest, the taxpayer would have to complete IRS form 8815, “Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989.”

This may be a useful strategy for a number of reasons:

  • 529 plans offer a broader set of investment solutions including popular age-based portfolios
  • Unlike Series EE or I bonds, tax-free withdrawals from 529 plans for qualified education expenses are available regardless of income level, while tax benefits on savings bonds are subject to the income phaseouts referenced above
  • Since contributions to a 529 plan are considered completed gifts, this can be a beneficial estate planning strategy

Contact clients and prospects who may hold these types of bonds to discuss the potential benefits of cashing out bonds and using the proceeds to fund a 529 plan. For more details, consult IRS publication 970, “Tax Benefits for College.”

Putnam 529 for America is sponsored by the State of Nevada, acting through the Trustees of the College Savings Plans of Nevada and the Nevada College Savings Trust Fund. Anyone may invest in the plan and use the proceeds to attend school in any state. Before investing, consider whether your state’s plan or that of your beneficiary offers state tax and other benefits not available through Putnam 529 for America. If you withdraw money for something other than qualified higher education expenses, you will owe federal income tax and may face a 10% federal tax penalty on earnings. Consult your tax advisor. Putnam Retail Management, principal underwriter and distributor. Putnam Investment Management, investment manager.

Request a prospectus, a summary prospectus if available, or an offering statement from your financial representative, call Putnam at 1-800-225-1581, or click on the prospectus section to view or download a prospectus. The prospectus and offering statement include investment objectives, risks, fees, expenses, and other information about the funds and Putnam 529 for America that you should read and consider carefully before investing.

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