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Presently, many grandchildren find themselves inheriting savings bonds left for them by deceased grandparents. Although savings bonds can be problematic when it comes to inheritance, inheriting savings bonds for education can be helpful. In fact, with a correct registration, the savings bonds may qualify for the education tax exclusion. According to TreasuryDirect the following must apply, in part, to qualify for the education tax exclusion:
When using bonds for your child’s education, the bonds must be registered in your name and/or your spouse’s name. Your child can be listed as a beneficiary on the bond, but not as a co-owner.
Ultimately, the registration for the savings bonds must be in a parent’s name to qualify for the education tax exclusion. Unfortunately, many grandparents mistakenly register the savings bonds in their own name while designating the grandchild as the beneficiary. Consequently, complications arise when applying for the education tax exclusion after redeeming the savings bonds.
Inheriting Savings Bonds
When a grandparent dies, leaving savings bonds, it’s important to determine who inherits the savings bonds. Accordingly, TreasuryDirect provides the following guidelines on inheriting savings bonds:
- When one person is named on the bond and that person dies: The bond is part of that person’s estate.
- If two people are named on the bond and both have died: The bond is part of the estate of the person who died last.
- If two people are named on the bond and one dies: The surviving person becomes the owner as if the survivor had been the owner from the time the bond was issued.
Since only two names can exist on a bond, the determination process is straightforward. However, when trying to qualify for the education tax exclusion, the ownership determination becomes very important.
Qualifications for the Education Tax Exclusion
If the inherited savings bonds are for higher education, understanding the guidelines on how to qualify for the education tax exclusion is important. Accordingly, TreasuryDirect describes the education tax exclusion as follows:
The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible Series EE and I Bonds issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution.
To read the entire list of requirements, qualified expenses, and income limitations, click here.
Inheriting Savings Bonds for Education as a Beneficiary
When a grandchild inherits savings bonds from a deceased grandparent as a Payable on Death (POD) beneficiary, the grandchild becomes the sole owner of the savings bonds. Generally, this is not a problem if the intent of leaving the grandchild the savings bonds was for any purpose. However, for the purpose of qualifying for the education tax exclusion, there is a problem.
Unfortunately, rules concerning reissuing bonds will prevent a grandchild from changing ownership on the savings bonds. As a result, the grandchild will remain the sole owner of the savings bonds. Also, the grandchild will be responsible for the taxes after redeeming the savings bonds.
Inheriting Savings Bonds for Education Through the Will
If a deceased grandparent designates a grandchild as beneficiary for the savings bonds in the will, the executor should distribute and reissue the savings bonds to the beneficiary. To read the procedure to distribute and reissue savings bonds for executors with full powers, click here.
While completing the procedure, the executor can reissue the savings bonds in the name of a parent of the grandchild. In essence, this would, in part, qualify the savings bonds for the education tax exclusion.
Additionally, reissuing savings bonds to change the owner is a taxable event. Since the savings bonds are property of the estate, the executor has options on how to handle the tax liability as explained in the article The Implications of Redeeming Savings Bonds that are Property of the Estate under the heading IRS Rules for the Decedent who Deferred Reporting Interest. In short, continuing to defer reporting interest income until after redeeming the reissued savings bonds is possible. As a result, the parent of the grandchild can apply for the education tax exclusion.
Since reissuing bonds have tax consequences, the complications vary. Therefore, for common executors, confer with a tax professional to implement the best option to save on taxes.
An Important Consideration for Savings Bonds Inherited Through the Will
The executor must know that the registration of the savings bonds shapes the handling of savings bonds, not the will. So, if all owners of the savings bonds died, the savings bonds are property of the estate. Therefore, according to TreasuryDirect, the executor has two options in handling savings bonds:
- Redeem the savings bonds
- Distribute and reissue the savings bonds to the entitled owners.
However, that doesn’t mean the executor should completely disregard the instructions of the will. One important priority for the executor is to uphold the decedent’s wishes written in the will. Therefore, the executor should opt to distribute and reissue the savings bonds to the beneficiaries. Furthermore, if the beneficiaries are grandchildren, the executor can opt to reissue the bonds in the parent’s name.
Additional Facts about Inherited Savings Bonds
This article assumes that the inherited savings bonds are paper bonds. According to TreasuryDirect, when reissuing series EE and series I savings bonds, the reissued bonds will be in electronic form. Consequently, before reissuing paper savings bonds, the recipient of the newly reissued savings bonds must open an account with TreasuryDirect.
Additionally, each form used to distribute and reissue savings bonds requires a certified signature. So, a medallion signature guarantee stamp must be on the forms from a financial institution that handles savings bonds.
A Final Word about Savings Bonds
Although inherited savings bonds can be useful, consequences result from a faulty registration. In addition, because the savings bonds pay very little interest, many financial professionals advise against savings bonds. The financial professionals feel that savings bonds are potentially more troublesome than they are worth when it comes to inheritance. After spending some time with TreasuryDirect, I understand the guidance of the financial professionals.
Finally, there are better options to save for a grandchild’s education, such as a 529 college savings investment account. However, if you prefer savings bonds for education savings, make sure to register the savings bonds in the parent’s name.
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TreasuryDirect – TreasuryDirect are the experts on all series of savings bonds. The representatives helped me tremendously and are very responsive to questions.
The Implications of Redeeming Savings Bonds that are Property of the Estate – The article will spell out the tax implications of reissuing bonds with beneficiaries listed in the will.