Tax Breaks

What Grandparents Need to Know About Using Savings Bonds for a Grandchild’s Education

It’s not easy, but grandparents can avoid a tax bill when redeeming savings bonds to pay for a grandchild’s college costs.

Question: Can I use my series EE or I bonds to pay for a grandchild’s college—and save on taxes?

Answer: You can redeem savings bonds to help cover the cost of college, and in some cases the interest the bonds earn won’t be subject to federal income tax. But as a grandparent, you’ll likely have to jump through some hoops and meet income limits to avoid the tax.

Under the Education Savings Bond Program, you can exclude bond interest from your income if you use bond proceeds to pay qualified education expenses for yourself, your spouse or a dependent. If your grandchild is not a dependent that you list on your tax return, you won’t meet the standard.

Several other restrictions apply, too. EE bonds must be issued after 1989 (all I bonds are eligible). The bonds must be issued either in your name or in both your name and your spouse’s name as co-owners (a dependent may be listed as a beneficiary but not as an owner). Plus, you must have been at least 24 years old at the bonds’ issue date. The tax exclusion begins to phase out for those with modified adjusted gross income exceeding $81,100 ($121,600 for joint returns) for the 2019 tax year, and it disappears when MAGI reaches $96,100 or more ($151,600 for joint returns). If you’re married, you have to file a joint return to exclude bond interest from income. And education expenses have to be incurred in the same tax year that the bond is redeemed.

Grandparents who are not eligible for the tax break because they don't claim their grandchildren as dependents but who are determined to get it can use a workaround that complies with IRS rules, says Mark Kantrowitz, publisher and vice president of research of Savingforcollege.com. Qualified education expenses under the Education Savings Bond Program include tuition and fees (but not room and board or books) at a post-secondary institution, as well as contributions to a Coverdell education savings account or a 529 college-savings or prepaid-tuition plan. A grandparent could list himself or herself as the beneficiary on a 529 plan—the grandparent doesn’t have to be the plan’s owner, so you could use a 529 that the child’s parents own—then redeem the bonds and contribute the proceeds to the 529 within 60 days of the redemption. After that, you could change the beneficiary on the 529 plan to the grandchild’s name.

Not only could the grandparent take advantage of the tax exclusion, but the grandchild would be able to use the money for a broad range of education expenses. Withdrawals from a 529 are tax-free for college tuition and fees, as well as room and board, books, and computers. (Plus, in most states, up to $10,000 yearly is tax-free to pay school tuition in grades kindergarten through 12.)

Most Popular

What Biden Will Do: 24 Policy Plays to Expect From the Next Administration
Politics

What Biden Will Do: 24 Policy Plays to Expect From the Next Administration

The Kiplinger Letter forecasts President-Elect Joe Biden’s biggest priorities -- and the likelihood of progress on them.
November 19, 2020
The 13 Best Healthcare Stocks to Buy for 2021
Kiplinger's Investing Outlook

The 13 Best Healthcare Stocks to Buy for 2021

Most of the best healthcare stocks for 2021 will have some sort of ties to COVID, whether it's producing a vaccine or cure, or benefiting from the vir…
November 20, 2020
16 Worst Gifts to Impulse Buy for the Holidays
shopping

16 Worst Gifts to Impulse Buy for the Holidays

Don't let those holiday sale promotions persuade you into buying something now that will be much cheaper later.
November 18, 2020

Recommended

Bonds: 10 Things You Need to Know
Investing for Income

Bonds: 10 Things You Need to Know

Bonds can be more complex than stocks, but it's not hard to become a knowledgeable fixed-income investor.
July 22, 2020
11 Surprising Things That Are Taxable
Tax Breaks

11 Surprising Things That Are Taxable

If you picked up any of the income or property on our list, make sure you declare it on your next tax return.
December 3, 2020
The 7 Best Bond Funds for Retirement Savers in 2021
bonds

The 7 Best Bond Funds for Retirement Savers in 2021

Fixed-income investors have a rocky hill to climb in 2021. These are seven of the best bond funds to buy for this tall task.
December 2, 2020
13 States That Tax Social Security Benefits
social security

13 States That Tax Social Security Benefits

You may have dreamed of a tax-free retirement, but if you live in these 13 states, your Social Security benefits are subject to a state tax. That's on…
December 2, 2020