Tax-Free Saving Plan Can Help Pay for College

Starting Jan. 1, parents can take advantage of a savings bond program that will allow them to put away money for their children’s college education tax-free.

The program involves the U.S. Treasury’s Series EE savings bonds, which have been around for years. The difference is that federal tax on the bonds’ interest will be forgiven if the proceeds are used for tuition. Savings bonds always are exempt from state and local taxes.

The program is limited to residents at least 24 years old who meet certain income requirements: married couples with adjusted gross incomes of $60,000 a year and under, and single people with incomes of $40,000 and under.

For those with higher incomes, the tax-deductibility is reduced according to a scale. Married couples with incomes of $90,000 and over and singles with incomes of $55,000 or more cannot participate.

The bonds may only be bought by parents for their children; other relatives may not participate.

Using savings bonds to put away money for college education has long been popular, but the 1986 federal tax code revision made it less advantageous.

Before the tax law changes, parents typically would buy bonds in their child’s name and declare the interest as income on tax forms filed for their children. This way, the child usually would pay no tax since the interest income would be lower than the child’s minimum taxable income.

However, the revised code taxes children under age 14 at their parents’ marginal tax rate instead of at the children’s rate. That eliminated some of the tax advantage.

The new program should restore the popularity of savings bonds for college tuition funding, said Stephen Meyerhardt, a spokesman for the Treasury’s savings bond program.

He said the new program is simpler than the traditional way of putting away college funds in bonds because there is no need to file annual tax forms for the children.

Instead, the bonds will be bought in the parents’ names and interest will only be declared when a bond is cashed in to pay for tuition. He said the Internal Revenue Service is still working on rules for how this interest will be excluded from taxation.

Series EE Treasury bonds sell for half their face value. The face value is paid at maturity. They can be bought for as little as $25 and are sold at most banks and savings and loans.

Meyerhardt said the Treasury has been deluged with inquiries about the program. “Obviously, the potential audience is huge,” he said last week.

While university officials generally praise the savings plan, they say they wish it had been extended to grandparents and students as well.

Richard F. Rosser, president of the National Assn. of Independent Colleges & Universities, agreed there should be great demand for the program.

“It’s simple and it’s uncomplicated,” he said. “This may very well become an important savings program for just taking it out of your monthly wages. People have bought EE bonds for years through payroll deductions.”

This is not the first college bond program. Several states have marketed some of their normal state revenue bonds as tuition savings bonds.

These bonds, like Treasury bonds, are zero-coupon bonds, meaning there is no annual interest payment, or “coupon.” That’s why they’re sold at a discount, with their face amount paid at maturity.