Bonds can't be spent tax free to pick up private school tab

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And know the rules before deciding on a 401 (k) withdrawal

September 03, 2000|By Neil Downing | Neil Downing,PROVIDENCE JOURNAL

I would like to know if EE bonds and I bonds can be used tax free for college tuition only, or whether [they] can also be used for private school, like elementary or high school.

Bonds get the tax break only if they're used for college costs, said Internal Revenue Service spokeswoman Barbara C. Shuckra.

Your question is timely, because it's back-to-school season - a good time to think about education expenses and how savings bonds may help.

In general, you must pay federal income tax on interest you earn with a savings bond. But you may be able to escape some or all of the tax if you cash your bonds and use the proceeds to pay for college, said John J. Foley, spokesman for the Bureau of the Public Debt, which runs the savings bond program. To be eligible, however, you must clear some hurdles. For example:

Only Series EE and Series I bonds purchased since Jan. 1, 1990, are eligible.

The parent or guardian must be registered as owner (or owners) of the bond or bonds. The child cannot be listed as an owner, but can be listed as a payable-on-death beneficiary.

You must use the proceeds only at a "qualified post-secondary institution," such as a college, university or technical institute. Elementary, middle and high schools - however expensive - don't count. The proceeds must be used only for tuition and fees; room, board and books - although costly - don't count. And you must pay the costs in the same year you cash the bonds.

If you're single, you may qualify for the full tax break if your adjusted gross income (AGI) is $54,100 or less in 2000. (You get a partial tax break on AGI between $54,100 and $69,100, and no break at $69,100 or higher. You can find your AGI by looking at the bottom of the cover of your Form 1040.)

If you're married and filing a joint federal income-tax return, you may get the full break if AGI is $81,100 or less. (You get a partial tax break on AGI between $81,100 and $111,100, and no break at $111,100 or higher.)

There are lots of other details, too many to list here. For more information, see IRS Publication 970, "Tax Benefits for Higher Education." For your free copy, visit your local IRS office, call (800) 829-3676, or see the agency's Web site: www.irs.gov. The bond program's Web site also has details on the tax-free education feature: www.savingsbonds.gov.

In 1998, I became disabled and unable to work, and in order to pay bills and pay my rent, I had to use my 401(k). No one told me that, because I had a disability, I didn't probably have to pay penalties or taxes. Is there something I can do concerning this situation?

Maybe. There are two issues here:

TAXES: In general, money you withdraw from a 401(k) retirement-savings plan is subject to federal income tax, and state income tax, too, depending on where you live (Rhode Island taxes withdrawals). Only after-tax contributions aren't taxed when withdrawn.

PENALTY: In general, money you withdraw from a 401(k) plan is subject to a 10 percent early-withdrawal penalty, unless you qualify for an exception. (If you qualify, you can file an amended tax return for a refund of the penalty amount you accidentally paid, said the IRS' Shuckra.) For instance, there's no penalty on withdrawals made on account of your disability, but you must be "totally and permanently disabled" to qualify, Shuckra said.

Even if you don't qualify for that exception, there are others. For instance, withdrawals generally won't be penalized if you're 59 1/2 or older at the time you withdraw the money, or if you're 55 or older and leave your job permanently, Shuckra said.

This is only a general look at a complicated subject. For more information, consult a tax professional. For details on avoiding the penalty on withdrawals from 401(k) plans, see IRS Publication 17, "Your Federal Income Tax."

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