Savings bonds can be used for college, but be careful

Also: You can test-run your Fafsa, years before your child goes to college.

  • By Chana R. Schoenberger,
  • The Wall Street Journal
  • College Planning
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  • Investing in Bonds
  • Bonds
  • College Savings
  • College Planning
  • Financial Planning
  • Investing in Bonds
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  • College Planning
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We again asked experts to help answer readers’ questions on saving and paying for higher education.

Q: How can I use Series EE savings bonds to fund college?

A: These U.S. government bonds are popular because they are extremely safe, though that is also why they earn ultralow interest.

Series EE savings bonds can be used to pay for higher education, but there are some tax implications to consider, says Deborah Goodkin, managing director at NEST 529 College Savings Plans, Nebraska’s state program. There are restrictions: Interest on Series EE bonds issued after Dec. 31, 1989, is tax-free, but only if used by qualified taxpayers (those who meet the IRS’s income limits, for example) for qualified educational expenses or rolled into a “529” college-savings account, prepaid tuition plan or Coverdell ESA. You should check with a tax adviser about your particular situation.

Also, qualified investors who seek to contribute the proceeds into a 529 without paying taxes on the interest must do it within 60 days of the redemption and within the same tax year, says financial adviser Sean Flynn of Essex Financial. Like all contributions to a 529, funds grow tax-free and earnings won’t be taxed when you withdraw them for qualified expenses, Ms. Goodkin says.

You probably want to start with bonds you bought first, since they are closer to maturity and will be worth more. Be aware that you have to use the bonds’ proceeds for qualified expenses the same year that you redeem them, Mr. Flynn says.

Q: Can appreciated stock be transferred to a grandchild’s 529 account without capital-gains consequences for the donating grandparent, or would it have to be sold first, with the grandparent paying the tax?

A: The grandparents have to sell it first and pay the capital-gains tax, Mr. Flynn says, because one can only contribute cash to a 529 account.

Q: Do I need to file a Fafsa [Free Application for Federal Student Aid] now for a student who won’t apply to college for a few years?

A: “The earliest you can fill out and submit Fafsa is Oct. 1 of your child’s senior year of high school,” Mr. Flynn says. However, parents can get an earlier sense of where they stand by using the Fafsa estimating tool online, called Fafsa4caster.

Q: Once our daughters graduate from college, we would like to transfer ownership of their 529s to them so they can manage the remaining money in grad school. Is there a downside to making them owners?

A: “There is no downside to this as long as they are using these funds for qualified educational expenses at an eligible educational institution,” including IRS-specified costs such as books, supplies, tuition, fees, and room and board, Ms. Goodkin says.

Q: I have an annuity that will begin paying out in five years. I would like to make my grandchildren’s 529s the beneficiary. Pros and cons?

A: You’ll have to contribute after-tax dollars to a 529, but otherwise there are no real advantages or disadvantages to using annuity payouts in this way, Mr. Flynn says. “It’s important to work with your accountant to make sure you are staying within the annual gift-tax exclusion each year or over the course of five years.”

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