Savings bonds are a relatively safe way to invest and there’s more than one way to put them to work. Series EE and I bonds issued after December 31, 1989 can be used to cover the cost of earning a college degree. If you want to use bonds to pay for your child’s education expenses, it’s a good idea to weigh the advantages and disadvantages of this kind of investment.
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What Are the Pros?
If you’re wondering what’s so great about savings bonds, here’s a quick rundown of the main benefits they offer to savers.
1. Bonds Are Low-Risk Investments
Savings bonds are some of the safest investments around because they’re backed by the federal government. That means they come with a virtually guaranteed rate of return. When you’re saving in a 529 plan, you’re taking a bigger gamble. That’s because the money is usually invested in mutual funds that are subject to the whims of the market.
2. Interest May Be Tax-Exempt
Bonds earn interest the same way that a savings account or CD does but you don’t always have to claim it as income on your tax returns. As long as you’re cashing out bonds specifically to pay qualified education expenses and you’re within the income guidelines, some or all of your interest can be tax-free. This exemption applies at the federal level because your interest won’t be subject to state or local income tax.
3. Parents’ Assets Have Less of an Impact on Financial Aid
If you know your child is going to have to supplement what you’ve saved with student loans or grants, you won’t have to worry about bonds counting against them too much. Student assets weigh more heavily in financial aid decisions. So as long as you’ve purchased Series EE or I bonds in your name, they shouldn’t have a substantial impact on your child’s aid package.
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What Are the Cons?
While there are plenty of upsides to using savings bonds to cover tuition costs, there are a few drawbacks that are worth keeping in mind.
1. Returns Are Smaller
Safety comes at a price and in the case of savings bonds, you could be missing out on higher earnings. If you have a 529 plan, for example, your investment has the potential to be worth a lot more than your savings bonds returns. With the cost of tuition rising year after year, you’ll need to consider whether sacrificing returns for the sake of avoiding risk is really worth it.
2. There’s a Potential Tax Penalty
Education savings bonds are designed to be used for just that – education expenses. You must cash them out to pay for qualified expenses such as tuition and fees to avoid having your interest taxed. And you can only use them at colleges and universities that are eligible to participate in federal student aid programs.
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If you use the money for education expenses that aren’t covered or for something else altogether like a home improvement project, bond proceeds can be fully taxable at your regular rate. Cashing in thousands of dollars of bonds could lead to a huge tax bill so you’ll need to plan ahead for how they’re going to factor into your tuition payment plans.
Who Should Purchase Education Savings Bonds?
In general, Series EE and I bonds only make sense for certain types of investors. If you’re already saving through a 529 plan and you’re looking to balance out your risk level, for example, adding them to your portfolio could be a good idea. The potential to exempt the interest from tax could also be tempting if you’re in a higher tax bracket.
The most important thing to keep in mind is that bonds are a long-term investment. So you’ll only want to invest money that you won’t need for a while.
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