Can You Use Series EE Savings Bonds to Repay Student Loans?

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Do you have any savings bonds? Those old paper bonds that some grandparents got for newborn grandchildren to help pay for college could be worth big bucks today.

If you’re in college or plan to go to graduate school, you can use those savings bonds for education to avoid taking out more student loans. Let’s take a look at how to use Series EE bonds for education tax-free, or how you use savings bonds to pay student loans faster — specifically:

What is a savings bond?

A savings bond is a tool used to loan a small amount of money to the government in exchange for interest. The first savings bonds were issued March 1, 1935, after President Franklin D. Roosevelt signed a law authorizing the U.S. Department of the Treasury to issue a new type of savings security, the savings bond.

The first savings bonds, known as “defensive bonds,” were issued to help fund U.S. involvement in World War II. After the war ended, many Americans held their bonds so they would grow in value before cashing them in.

The treasury department currently issues Series EE bonds and Series I bonds. They are similar but have some important differences in how they earn interest. For the rest of this article, we will focus on Series EE savings bonds.

How Series EE savings bonds work

Series EE savings bonds are sold at face value and earn a little bit of interest each month. As of November 2020, the annual interest rate for Series EE bonds issued through April 2021 is 0.10%. While the interest rate is low, the bonds are virtually risk-free.

The treasury department guarantees that the bond’s value will double 20 years after issue, at which point it can change the interest rate or the way interest is earned. After 30 years, the bonds stop earning interest. So, for example, if you pay $100 for a Series EE savings bond in 2021, it would be worth at least $200 by 2041.

Savings bonds are issued in any denomination above $25. People can buy up to $10,000 per series in electronic savings bonds per year.

Through 2012, savings bonds could be bought through banks and other financial institutions, but now they can only be purchased online through TreasuryDirect.gov. Existing savings bonds can be redeemed through a bank or TreasuryDirect.

Can you use savings bonds for student loans?

Because Series EE savings bonds are low risk and guaranteed to double in value in 20 years, they are among the best savings accounts for a grandchild. If Mom and Dad keep the savings bonds safely tucked away for years, the child can use savings bonds for college or pay off student loans.

Series EE bonds earn a small, steady amount of interest each year. If you’ve received an EE savings bond for education or another future cost, you can see how much it’s worth using the TreasuryDirect calculator.

Your EE bonds could be helpful toward covering your college costs. You might even consider rolling mature savings bonds into your 529 college savings plan or a similar vehicle that produces greater returns than the EE series. If you choose that route, you wouldn’t give up all tax advantages, as 529 plans come with their own set of perks.

Using bond proceeds to repay education debt, however, is a tricker question.

Interest rate on savings bonds vs. interest rate on student loans

Simply put, Series EE savings bonds are earning interest for the holder while student loans — whether federal or private — are charging the borrower interest.

While you’re earning interest at a 0.10% rate on Series EE bonds, the interest rate for federal loans ranged from 2.75% to 5.30% for the 2020-2021 school year —with private loans generally charging even higher rates. That means that even though you’re making some money on EE bonds, it likely won’t compare to what you’re being charged in interest on your student loans.

If you’re considering using your savings bonds for college loans, keep in mind that they can help pay off some debt but likely won’t cover the entire cost. This is because the interest rates on federal and private loans are much higher than the amount you’re earning on your EE bonds for education. Also, if you cash in savings bonds that are less than five years old, you’ll likely be charged a penalty.

Conventional wisdom says it’s best to pay off higher-interest loans first and then move on to lower-interest loans. When you cash out your savings bonds for college costs, it’s smart to pay off private loans first because they likely have the highest interest rate. Then, with any leftover bond money, you can start paying down your federal student loans.

Do you have to pay taxes when cashing in savings bonds?

Interest on Series EE savings bonds is taxable on your federal tax return, but not at the state or local level. Through 1989 that was the rule across the board, but Series EE savings bonds purchased on or after Jan. 1, 1990, have different rules when it comes to using your savings bonds for college costs.

In 1990, Congress created the Education Savings Bond program. Now, all savings bonds issued on or after Jan. 1, 1990, can be redeemed tax-free if the money is used to pay qualified education expenses.

Tax advantages of savings bonds

In many cases, you’re required to pay taxes on any interest earned in a calendar year. However, one of the pros of using savings bonds to pay student loans is that you may not have to pay taxes on the interest earned.

Taxpayers who are 24 years or older and meet filing status and income requirements can exclude the interest earned on savings bonds from their gross income if the bond was used toward qualified education expenses at eligible schools.

Additionally, savings bonds are exempt from state and local taxes, which is especially helpful for people who live in a state with a high income tax. Lastly, people can defer taxes on the interest earned until the bond matures at the 30-year mark or they redeem the bond, whichever occurs first.

Tax disadvantages of savings bonds for college

There are some tax disadvantages of savings bonds. Primarily, not everyone is eligible for tax breaks on EE bonds. Depending on how much you make as a single taxpayer or a married taxpayer filing jointly, you may not be eligible for the tax advantage. If you’re single and your gross income is $94,550 or more, or if you’re married and your gross income is $149,300 or more, you won’t be eligible for the tax exemption.

How to use Series EE savings bonds for education tax-free

Let’s say you are a college student enrolled at a major university or trade school. If the school is qualified for federal student loan programs like federal Stafford loans and federal Perkins loans, you are eligible to cash in your savings bonds for education tax-free. (Note that the Perkins loan program was closed to new borrowers when it expired Sept. 30, 2017.)

The loan proceeds must be used for tuition and fees directly related to your degree program. The funds cannot be used for books, room and board or other extracurricular activities, like clubs and fraternity dues.

If you cash in savings bonds for college in a single calendar year that have accrued more interest than you need (only interest is taxed, not the original principal), any excess interest is taxable. For example, if you redeem savings bonds that have earned $10,000 in interest and your tuition and fees were $9,500 that calendar year, you would pay income tax on the remaining $500.

If you have any questions on how to handle your taxes, consult a qualified tax expert.

Why you may want to keep those bonds a while longer

Let’s consider four scenarios when it could make sense to employ your EE bonds for education or hold on to them into the future: 

Andrew Pentis and Sage Singleton Evans contributed to this report.

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