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I set up Series I Bond accounts for several of my nephews’ children. I have since opened up 529 accounts for them. Does it make sense to move the money out of the I-bond account to the 529 after one year, and lose the three months of interest or wait for the five years? I am not sure the rate of the I-bonds going forward is going to make it worth keeping them. Also, I am not sure of the tax implications of the I-bonds vs. the 529, especially now that funds not used in the 529 account can be moved into a Roth account if not used for educational purposes. Can you help?
A Helpful Aunt
Dear Helpful Aunt,
You’re the nicest aunt, and I’m sure your nephew appreciates you very much. But you’re asking a bit of a trick question, so let’s break it down:
The main complication with your situation is that when you gift Series I bonds, which are a savings bond issued by the U.S. Treasury, you have to provide a Social Security number for the recipient, and once gifted, those funds actually belong to the recipient.
With a 529 plan, on the other hand, you remain the owner of the funds while the money is in the account, and you name beneficiaries to receive it for educational purposes. You can change the beneficiaries will, and even designate the money for yourself.
So moving money that you gave to your nephew’s children will require their permission or your nephew’s permission as their guardian. They would have to cash out the money, and give it back to you to in order for you to deposit it into the 529.
After you solve that part of the puzzle, there is the tax questions, which are different on the state and federal levels. And after that, you get to the analysis of which is the better investment right now, which depends largely on the age of the children involved and where you live.
How to cash out and transfer
If you were just taking your own I-bond money and transferring it to a 529 you own to use for anyone’s educational purposes, the process would be to cash out the money from your account at Treasurydirect.gov and deposit the money into the 529 that you own. You could also use the funds to pay directly for college expenses once you cash it out. There’s no way to directly roll it over into the 529, like you can with a 401(k) to an IRA, and the government won’t issue a tuition check directly to a college.
Either way avoids the federal tax on the interest if you meet all the requirements, says certified financial planner Dean Tsantes, of VLP Financial Advisors in Vienna, Va. In order to qualify for the tax exemption, you have to complete the transaction within 60 days, be over 24 when the savings bonds are issued and meet the income threshold of the year you cash out. Currently, that’s a modified adjusted gross income of $106,850 for a single person, or $167,800 for married couple, filing jointly. I-bonds are already exempt from state income tax.
If your nephew’s kids are young, they won’t qualify for the federal tax exemption, but if they have no other income when they cash out, or they make less than the standard deduction, they may not owe tax overall.
“The I-bond side of it is all about who owns it,” says Jeremy Keil, a financial planner from Milwaukee, who also hosts a podcast and YouTube channel
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On the 529 side of the equation, it’s all about state taxes instead. With a 529 College Savings account, you put in money that’s already been taxed and it grows tax-free if you use the money for educational purposes. A new law allows you now to rollover up to $35,000 of leftover 529 funds into the Roth IRA of the beneficiary. Some states give a tax deduction for contributions, so you could benefit from moving the money, depending on where you live. For instance, in New York you can deduct up to $5,000 per taxpayer ($10,000 if married) for contributions to a state plan, while in Wisconsin, it’s $4,000 per beneficiary.
“But what would be the point if you live in Florida, where there’s no state income tax?” says Keil. “Or California, where there’s no deduction for contributions?”
Which strategy is better?
When it comes to deciding which type of savings for college is better, it will depend on when you bought your I-bonds and the age of the children. I shifted to saving for college in I-bonds two years ago, but I have teenagers about to go to college. When inflation was high and stocks were doing poorly, it was worth it. Those I-bonds had a 0% fixed rate and the annualized variable rate has fluctuated from a high of 9.62% to 3.97% today (with a fixed rate for new buyers of 1.3%). I had planned to hold onto the I-bonds through their 5-year full maturity period and use them for my younger child, because otherwise you lose three months of interest if you cash them out sooner.
But because the variable rate has dropped so much and the stock market is doing better, I will probably use them soon for my older kid. To minimize my taxes, I will likely roll those funds into my 529 account for the state tax deduction before I spend them. But moving the money will likely not boost my return, because I’m so close to spending the money, it would go into the most conservative option.
“A stable-value fund in a 529 is running about 3%,” says Keil. “It might be a bit of a ‘why bother.’”
If you have a longer time horizon, it might make more sense to make the 529 move and invest the money more aggressively. Or you can cash out the I-bonds you are holding that have a 0% fixed income rate and buy new I-bonds that have the 1.3% fixed rate, which is available at least through May and then do the transfer later — but still you’d run into the ownership issue on gifted I-bonds.
“This is the first time people are really thinking about selling I-bonds,” says Keil, because so many new people bought within the last two years when rates were highest. “They should look into it.”
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