A year ago, Series I bonds were a popular commodity on the market. Investors get the stability of a U.S. government bond with protection against inflation at a current annual rate of 6.89 percent. It's no surprise that people are curious about it.

With such a high return, investors in the Series I bond may be asking if they may use it in place of a 529 plan to fund future higher education costs. The following are some of the advantages and disadvantages of using the Series I bond in this manner.

What Is A Series I Bond, And How Does It Operate?

Bondholders of a Series I get interested at two rates: one is fixed, and the other is variable and resets every six months to account for inflation. The effect of inflation is neutralized, and your buying power is protected by the variable rate, which rises or lowers as inflation does.

Forgivable Debts and Tax Deductible Tuition

When used to pay for postsecondary education expenditures for the taxpayer, their spouse, or a dependent, interest received on I bonds is exempt from federal income tax. The percentage of the redemption earnings that can be excluded is determined by dividing the total amount of eligible education costs by that amount.

If $9,000 is used for eligible school costs after redeeming an, I bond for $12,000. Then, $4,500 of interest will be excluded. Scholarships and other forms of financial help that cover necessary expenditures cannot be used to deduct interest income.

College Savings With Series I Bonds

Series I bonds might be a good choice for college savings, while their interest rate is high. Suppose the bondholder uses the proceeds from the sale of their Series I bonds (or Series EE bonds) to pay for qualified higher education costs at a qualifying school. In that case, the interest received on the sale of the bonds can be excluded from the bondholder's taxable income.

• You cashed Series I or Series EE bonds issued after 1989 in the same tax year.
• You or a family member had eligible educational costs paid in the same tax year.
• You're not eligible to claim married filing separate status for tax purposes.
• You are a single, head of household, or qualified widower, and your MAGI is less than $98,000; if you are married filing jointly, your MAGI cannot exceed $124,800.
• You were 24 when your savings bonds were issued.

Series I College Savings Bonds Pros And Disadvantages

In some cases, the interest exclusion might make Series I bonds a more attractive alternative for people saving up for higher education costs. Added benefits and drawbacks of this method are as follows:

Pros

• One of the primary selling points of the Series I bond is the protection it provides against inflation, which helps to preserve your spending power.
• Presently, the Series I bond provides a competitive interest rate, especially considering the bond's high degree of safety.
• Interest earned on the bond may be excluded from gross income in the year it is cashed if the proceeds are utilized to pay for eligible higher education costs.
• This feature makes all interest earned on Series I bonds available for costs rather than being withheld for state or local taxes.

Cons

• The federal tax deduction for Series I bonds will be lost if the proceeds are not utilized for qualified educational expenses. After years of saving, you'll conclude that you won't be putting the bonds toward tuition.
• The Series I bonds give a high return currently, but that yield might shift lower when inflation decreases, and the Fed has been on a quest to stifle inflation.
• Yield and compounding may suffer over time; with the Federal Reserve increasing interest rates, yields will likely fall at some point, and the current high result may never be seen again. The returns on Series I bonds issued during the past decade, when inflation and interest rates were low, indeed disappointed many who purchased them.

Bottom Line

Investing in Series I bonds might be a wise decision for covering school costs this or next year, but their true worth will be shown over the long haul. The Federal Reserve is working to reduce inflation, which is necessary for the Series I bond to continue being an attractive investment for higher education. Although the Series I bond might be a good option for college funding shortly, it will not likely be sustainable in the long run due to growing tuition expenses.