<p>I have some Series EE savings bonds that are eligible to be used tax free for educational expenses. However, my son got some scholarships and now I'm finding that the amount of tuition is covered. Since the savings bonds can only be used for tuition and fees to get the tax exemption, whereas our 529 plan can be used for room/board and similar expenses, I'm thinking of cashing the savings bonds and using them to fund the 529 plan. </p>
<p>My question is this, if we aren't able to use all the $$ in the 529 plan to fund qualified expenses and we want to use the money to help pay off past loans (which is NOT a qualified expense), will the penalty and tax liability for using the $$ from the 529 be only on the earnings that the money accrued once it was placed into the 529 plan, or would the penalty and taxes be calculated on the earnings from the original bonds? </p>
<p>To make this more clear, say I paid $200.00 for a bond and it is now worth $400.00. I cash it and fund the 529 plan with the 400. The $$ is tax exempt at that point. A year down the road, let's say the $400.00 in the 529 has earned $30.00 and now there is $430.00 in the account, which I then withdraw and use for a non-qualified expense. Will I pay only the penalty/tax on the $30.00 or will I pay penalty/tax on $230.00 (the the total of all the earnings)</p>
<p>I've searched for the answer to this and cannot seem to find it anywhere.</p>
<p>I do not know the answer, but it would seem as though you would look through or collapse the transactions and then see that the entire $430 would be subject to the penalty.</p>
<p>I’m not a tax expert but my thought was that when you cash in the bonds and contribute the proceeds to a 529, that the tax-free event has occurred at that point and the new basis of that money in the 529 would be $400. </p>
<p>Yet this application for a rollover to a 529 seems to indicate that they would retain the prior basis of $200:</p>
<p>I would contact your 529 custodian and ask and see if their 529 rollover form asks for the same information.</p>
<p>Also, on page 59 of IRS Pub 970, there is an exception to the penalty for making non-qualified withdrawals from the 529 plan if the student received tax-free scholarships:</p>
<p>Adding that I believe the non-qualified distribution would have to be taken in the same year as the scholarships were received to qualify for the penalty exception.</p>
<p>The basis and earnings of the rolled over savings bonds will be identified and accounted for upon deposit into the 529 account, as will any other basis and earnings (past and future) in the 529 account. Each distribution from a 529 account is made with both basis and earnings using a pro rata method, and any penalty and/or tax would be assessed on the earnings portion only, depending on whether or not the expense that was paid for using the distribution is a QEE.</p>
<p>I don’t think you can double dip with the tax benefit. You may only redeem the bond directly for education expenses not to fund another education fund unless there is some sort of conversion (like 401k to IRA). You may want to find out if the bonds’ beneficiary is transferable or not. The worse scenario would be cashing out the bonds and pay the tax if you cannot use the money otherwise.</p>
<p>^^^
If the proceeds from savings bonds are rolled into a 529 account and the basis and earnings are reported and continue to be accounted for, there will be no tax benefit double dip.</p>
<p>I don’t understand this, can you explain? Do you mean that when I roll them over to the 529 that the earnings accrued on the bond will be kept as a separate line item?</p>
<p>No, when you roll them over the bonds will have their basis and earnings. The funds from the bonds will be merged into the 529 but the basis of the bonds will be added to the basis of the 529 and the rest will be earnings going forward.
BIllsho, IRS Pub 970, page 62 says redeeming the savings bonds to contribute to a QTP is a qualified education expense. </p>
<p>Okay, that makes sense. Thank you for clarifiying that! So now I just have to figure out how many of the bonds I will cash out to fund the TSP, so I don’t put too many in there than I have expected qualified expenses.</p>