Tax-Free Conversion of US Savings Bonds to 529 Plans
Posted on Thursday, August 12, 2021
ShareThere is a possible exclusion of US Savings Bond interest income if the bonds are cashed in and used for qualified higher education expenses. In the past, only direct expenses of tuition and fees were allowed to claim the income exclusion. But Qualified expenses now include contributions to 529 savings plans. So, taxpayers have the opportunity to transfer these funds into a 529 plan tax-free.
The details of how to do this tax-saving technique were vague at first and are now more readily available.
There are specific procedures, qualifications, and income limitations involved, so it must be done carefully. In general, the exclusion, claimed on Form 8815 on the 1040, has these requirements:
1. Qualifying bonds are Series EE Savings Bonds purchased after 1989 and all Series I Savings Bonds. Bonds in the child’s name generally do not qualify.
2. The bonds must be issued in your name and/or your spouse’s name. The bond owner must be over age 24.
3. The bonds and proceeds must be used for qualified higher education expenses such as tuition and fees, but not room and board or books for you, your spouse or your dependents. Qualified higher education expenses are reduced by any tax-free educational assistance such as scholarships, VA education assistance, employer-paid educational assistance, tax-free 529 distributions and the American Opportunity Tax Credit.
4. Qualified expenses also include a qualified tuition program (529) or a Coverdell education savings account for you, your spouse or your dependent.
5. The income phase-outs are an important factor. For 2021, the exclusion phases out for a modified adjusted income between $83,200 and $98,200 for single fliers and $124,8000 and $154,800 for married filing joint filers. Married filing separate filers are ineligible. These amounts are indexed for inflation.
The phase outs must be watched carefully as the interest counts as income for purposes of the phase-out. These phase-outs provide no advantage for higher income taxpayers.
When using the 529 plan as the qualified education expense, the savings bonds cannot be directly transferred to the 529 plan account. Instead, the bonds must be redeemed, and the proceeds deposited into the 529 plan account. The proceeds must be deposited within 60 days of cashing the bonds and within the same tax year. If the entire proceeds are not contributed to the plan, then part of the savings bond interest would be taxable.
Many of our clients are interested in deferring income and funding education plans for grandchildren. A grandparent-owned savings bond would not generally qualify because the grandchild is not a dependent. There is a process that makes grandparents eligible:
The grandparent does not need to be the owner of the 529 plan but must be listed as the beneficiary of the 529 plan.
The grandparent redeems the savings bonds and contributes the proceeds to the 529 within 60 days. This allows the tax-free transfer of the total proceeds if the AGI limitations are met.
The beneficiary of the 529 plan is then changed from the grandparent to the grandchild.
Each step is followed independently. A grandparent could use the funds for continuing education, so changing the beneficiary is a common aspect of 529 plans.
The income exclusion is claimed on Form 8815 with the 529 plan is listed as the qualified expense. If this is an Indiana College Choice plan, the contributions are eligible for the credit.
Contributed By: Jessica Ogle, CPA | Partner | DWD CPAs & Advisors
Posted in Tax Topics For Individuals
Disclaimer: The information contained in Dulin, Ward & DeWald’s blog is provided for general educational purposes only and should not be construed as financial or legal advice on any subject matter. Before taking any action based on this information, we strongly encourage you to consult competent legal, accounting or other professional advice about your specific situation. Questions on blog posts may be submitted to your DWD representative.