You can't contribute savings bonds directly to a Coverdell Educational Savings Account or a qualified tuition plan, like a 529 plan, because contributions must be made in cash. To move money from a savings bond into either accont, you'll have to cash out your bond and transfer the proceeds. However, you might be able to exclude all of the interest income from your taxes if you use the savings bond proceeds to contribute a Coverdell or 529 plan. To qualify, you must have been at least 24 years old when you bought the bond, your modified adjusted gross income must fall below the annual limits, and you can't be married filing separately. In addition, you must deposit the proceeds into a Coverdell or 529 plan for a dependent you claim as an exemption.
Cash out your savings bonds and deposit your savings bond proceeds into the Coverdell or 529 plan for your dependent. For all of the interest to be tax-free, you must deposit all the proceeds -- not just the interest.Step 2
Complete IRS Form 8815 to calculate the amount of your exclusion. The exclusion allows you to avoid paying income taxes on the interest from your savings bonds when used for qualifying education expenses, including contributions to 529 plans and Coverdells. If you don't deposit all the proceeds, you have to prorate the interest between the taxable and nontaxable portions. For example, if you only deposit half the proceeds, half the interest will be taxable. If you only deposit 25 percent of the proceeds, then only 25% of the proceeds will be taxable.Step 3
Report all of the interest on line 1 of IRS Schedule B and the excluded interest on line 3 of Schedule B. The excluded interest is the amount that you don't have to pay taxes on because you contributed it to a Coverdell or 529 plan. The excluded interest is subtracted from your total interest, so as long as you deposit all the proceeds in the Coverdell or 529 plan, you won't pay any taxes on the interest.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."