Thorley Wealth Management, Inc. Elizabeth Thorley, MS, CFP, CLU, AIF CEO & President 1478 Marsh Road Pittsford, NY 14534 585-512-8453 x205 Fax: 585.625.0477 ethorley@thorleywm.com www.thorleywm.com U.S. Savings Bonds for Education Savings Page 1 of 5, see disclaimer on final page
U.S. Savings Bonds for Education Savings Introduction Two types of U.S. savings bonds--series EE and Series I--offer a special tax advantage for college savers. If the bond proceeds are used to pay qualified higher education expenses and other requirements are met (including income limitations), you pay no federal income tax on the bond's earnings. Series EE and Series I bonds can only be purchased electronically from the U.S. Treasury. To purchase bonds or to learn more, go to www.treasurydirect.gov. What are Series EE and Series I bonds? Series EE and Series I bonds are types of U.S. savings bonds issued by the federal government. The bonds are available in denominations (face values) ranging from $25 to $10,000. Every year you hold a Series EE or Series I bond, it earns interest. Interest is added to the bond monthly. The interest is paid to you at the time you redeem (cash in) the bond. The main difference between Series EE and Series I bonds is the interest earned on the bond. For Series EE bonds purchased on or after May 1, 2005, the interest rate paid on the bond is fixed for the life of the bond. (For Series EE bonds purchased before May 1, 2005, the interest rate paid on the bond is variable--it's tied to the average yield of other government securities.) A Series I bond earns interest based on a combination of a fixed rate and an inflation (variable) rate. The fixed rate remains the same throughout the life of the bond and the inflation (variable) rate is calculated twice per year based on government inflation measures. Both Series EE and Series I bonds continue to earn interest for up to 30 years. You can cash bonds in after one year, but if you cash them in before five years, you lose the last three months of interest (e.g., if you cash in a bond after 18 months, you get the first 15 months of interest). Strengths of Series EE and Series I bonds Earnings may be exempt from federal tax in some cases If you use the bond proceeds to pay qualified higher education expenses (tuition and fees) and meet other requirements (discussed below), you will owe no federal income tax on the interest earned on the bond. Earnings exempt from state and local taxes The interest earned on Series EE and Series I bonds is exempt from state and local income taxes. Caution: On the transfer of U.S. savings bonds, you are exempt from state gift taxes. However, you may owe state inheritance taxes. Bonds are backed by the credit of the federal government The federal government backs its bonds with its ability to collect taxes. Thus, your principal will be repaid unless the federal government defaults on its obligation to pay. Easy to purchase and redeem Series EE bonds can be easily purchased online at www.treasurydirect.gov. You don't need to go through a broker. Tradeoffs of Series EE and Series I bonds Page 2 of 5, see disclaimer on final page
Maximum purchase requirements The maximum purchase allowed per individual per calendar year is $10,000. So, if you receive a windfall of $100,000 next year, you can't invest it all in Series EE or Series I bonds for your child's college education. Tip: In a two-parent family, each spouse can purchase $10,000 worth of Series EE or Series I bonds per year, for a total of $20,000. Relatively low yield Series EE and Series I bonds typically earn a relatively low interest rate that may not keep pace with college inflation. Penalty for early redemption If you redeem a Series EE or Series I bond before it is five years old, you will pay a penalty equal to the last three months worth of interest. Example: Suppose you purchase a $10,000 Series EE bond for $5,000 in May of Year 1. You decide to redeem the bond 27 months later, in August of Year 3. The result is when you cash in the bond, you receive your original investment of $5,000, plus 24 months of accrued interest. You forfeit three months worth of interest. Minimum waiting period before redemption allowed You have to wait at least one year before redeeming a Series EE or Series I bond. Tax considerations Series EE and Series I bond interest is exempt from federal income tax if the bond proceeds are used to pay qualified higher education expenses (see Questions & Answers for a definition) and if the following requirements are met: The bond must be issued in 1990 or later The bond must be issued in the name of one or both parents (not the child's name) Married taxpayers must file a joint return The owner (purchaser) of the bond must be at least 24 years old The bond must be redeemed by the owner in the year it's used to pay qualified higher education expenses, and the bond proceeds must be used to pay the education expenses of the owner, his or her spouse, or his or her dependent(s) The owner must fall within established income restrictions (see Questions & Answers) If you don't meet these eligibility requirements, the bond's earnings will be subject to federal income tax. The interest can be reported in one of two ways: (1) in the year the bond is redeemed or, less commonly, (2) as it's earned each year (the accrual method). If you choose the second method, you must make a special election to do so. If the election is made, it applies to all savings bonds you own in the year of election and to all savings bonds subsequently acquired. If you make the election, you must report all income earned on the bonds from the date of acquisition. Example: You purchase a $10,000 Series I bond. In Year 1, it generates $700 in interest; in Year 2, $800 in interest. Without the election, you don't report any interest in Years 1 and 2. Instead, this interest will be reported in the future when you cash in the bond. If you make the election in Year 2, you must report the entire $1,500 interest earned to date. If the total proceeds (interest and principal) from your Series EE or Series I bond are greater than the education expenses you pay for the year, the IRS allows you to exclude only a portion of the interest from taxable income. Example: Assume you redeem $15,000 worth of Series EE savings bonds in Year 1 to pay your child's tuition at State University (and you otherwise meet all the eligibility requirements). During Year 1, you pay $11,250 worth of tuition and fees. The result is that you can exclude only 75 percent of the interest received on the bonds' redemption ($11,250/ $15,000) because your redemption exceeded the education expenses paid for that year. Caution: Once you make the election (and switch to the accrual method for reporting interest), it's difficult, though not impossible, to change back. Page 3 of 5, see disclaimer on final page
Series EE and Series I bonds are a reportable asset under the federal formula for determining financial aid eligibility. In addition, colleges will consider any interest earned as income (regardless of whether or not it's tax exempt) and will assess it for financial aid purposes along with your other income. Tip: When you cash in Series EE and Series I bonds to help pay college expenses, you reduce your aid eligibility. The reason is your income has now increased. To avoid this result, consider cashing in the bonds after January 1 of your child's junior year of college, because income earned after that date won't affect your child's aid eligibility (at least with respect to any aid for undergraduate education). Questions & Answers My spouse and I have a combined annual income of $115,000. Would we be able to exclude the interest earned on our Series EE bonds from income? Yes. For 2016, married couples filing jointly with modified adjusted gross incomes (MAGIs) of $116,300 (up from $115,750 in 2015) or less and single parents with MAGIs of $77,550 (up from $77,200 in 2015) or less at the time the bonds are redeemed are exempt from federal income tax on Series EE and Series I bond interest if the bonds areused for qualified higher education expenses. The income tax exclusion is phased out for couples filing jointly with MAGIs between $116,300 and $146,300 and single parents with MAGIs between $77,550 and $92,550. These income limits are indexed for inflation each year. There is a catch in determining your MAGI. Namely, your income for the year you redeem the bonds includes all of the interest the bonds have earned to date. Ironically, the addition of this interest income may push some families right over the income cutoff, thus eliminating their income tax exclusion. What are qualified higher education expenses? Qualified higher education expenses for purposes of excluding the interest on Series EE and Series I bonds include tuition and fees, but not room and board. The tuition and fees must be actual out-of-pocket costs. Thus, any tax-free scholarships, educational assistance allowances, or payments (other than gifts or inheritances) that your child receives must reduce these expenses. Caution: The definition of qualified higher education expenses for purposes of Series EE and Series I bonds differs from the definition of qualified higher education expenses for purposes of the American Opportunity credit, Lifetime Learning credit, prepaid tuition plans, and student loan interest deduction. Tip: Contributing your Series EE or Series I bond proceeds to a Coverdell education savings account, a prepaid tuition plan, or college savings plan counts as a qualified education expense. Tip: The amount of qualified education expenses used to determine any federal income tax exclusion on Series EE or Series I bonds must be reduced by the amount of expenses taken into account in determining the American Opportunity credit and the Lifetime Learning credit. In other words, if you claim one of these credits for certain educational expenses, you can't cash in your Series EE or Series I bonds to pay those same expenses and still claim the tax break on the bond's interest earnings. Page 4 of 5, see disclaimer on final page
Securities and advisory services offered through Commonwealth Financial Network member www.finra.org/www.sipc.org, a Registered Investment Adviser. Fixed insurance products and services offered through CES Insurance Agency. This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Investors should consult a tax or legal professional regarding their individual situations. Thorley Wealth Management, Inc. Elizabeth Thorley, MS, CFP, CLU, AIF CEO & President 1478 Marsh Road Pittsford, NY 14534 585-512-8453 x205 Fax: 585.625.0477 ethorley@thorleywm.com www.thorleywm.com Page 5 of 5 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016