EE Bonds Used to Fund 529 Plan

When planning for the education expenses of a child or other relative, you can choose from several approaches that provide tax benefits. U.S. Treasury Series EE savings bonds provide tax-deferred income that may escape income taxes if used for qualified education costs. A qualified tuition plan provides tax-free earnings when used for tuition and other qualified education expenses. It is often called a 529 plan, for the section of the tax code that created it.

EE Bonds

EE savings bonds pay a fixed rate of interest. They mature in 20 years but pay interest for another 10 years after that. You can exclude income on these bonds from federal income taxes by using the proceeds to pay qualified education expenses in the same year you cash them. However, using the proceeds to fund a 529 plan doesn't qualify for the education exclusion. You'll have to pay the taxes on the bond proceeds you use this way.

Education Tax Exclusion

The EE bond education tax exclusion has a number of restrictions. You must be at least 24 years old when you buy the bonds. They must be registered in your name or your spouse's, not your child's name. If married, you must file a joint return. Income limits apply, and those can change yearly. The bond proceeds must pay for tuition, fees and certain other costs, but not for books or room and board.

529 Plans

A 529 plan accepts after-tax contributions and shields earnings from income taxes. Plan proceeds are tax-free if you use them to pay for the qualified education expenses of the plan beneficiary, who must be a relative. Qualified expenses include tuition, fees, books, supplies, equipment, and room and board. States administer 529 plans, so details can vary. Some states provide income tax exclusions for these plans. The beneficiary must be enrolled on at least a half-time basis.

Considerations

The yearly interest on EE bonds is safe but can be tiny -- about 0.20, as of 2013. Therefore, the education tax exclusion these bonds offer may be insignificant. A qualified tuition plan isn't a risk-free investment, but it allows you to invest in stocks, bonds and mutual funds. You might earn substantially higher returns than with savings bonds, though you may also suffer a loss. These plans have no income limits and cover a broader range of education expenses.