Since they were first made available in 2001, 529 plans have become a popular way to save for a child’s college education, but there may be a better way. The advantages of a 529 plan is that you may be able to avoid state (but not federal) income taxes on your initial contribution, your investment grows tax free, and distributions from the plan are tax free as long as they’re used for “qualified education expenses” (if they’re not you may pay a penalty). But there’s another way for your money to grow tax deferred: U.S. savings bonds. Investment managers and mutual funds make no money from these since you must buy them directly from the federal government, so you don’t hear much about them. But consider this:
- 529 plans typically hold a significant percentage of bonds, 50% to 75% isn’t unusual.
- S. government bonds are the single largest holding in most bond funds.
- You pay a management fee in a 529 plan, Savings bonds have no management fee.
- You may pay no taxes on the interest if you use the proceeds for qualified education expenses for you or your child and don’t exceed the IRS income limitations ($113,950 modified adjusted gross income for married couples filing jointly in 2014).
- There is no penalty if you don’t use the funds for college expenses for your child. Your savings will still grow tax free, but you’ll pay federal taxes on the interest when you withdraw your money.
- You don’t have to designate who or what the bonds are for, you can save for all your children in one account
- You are limited to $10,000 per year per parent, are required to hold them for 1 year, and pay a small penalty if withdrawn before 5 years.
Two types of savings bonds are available EE & I bonds. EE bonds pay a fixed interest rate, currently 0.30%. I bonds may pay a fixed interest rate (currently it’s zero), and also adjust for inflation. Over the past 5 years the inflation rate has averaged about 1.6%. I bonds also have the advantage of paying higher interest rates if the inflation rate goes up. I bonds are the way to go.
See http://www.treasurydirect.gov/indiv/products/prod_ibonds_glance.htm for complete information on I Bonds.
Please feel free to contact me if you have any questions.