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Bonds good for college savings

Just thinking about the cost of college education is enough to give a parent an anxiety attack.

The average cost of tuition this school year is $1,694 at four-year public colleges and $8,737 at private colleges, according to statistics compiled by the College Board.

To make matters worse, those costs have risen an average of 5 to 9 percent each year for the last five years. When room and board and future inflation are rolled in, the numbers get even more frightening.

However, those helpful folks we send to Congress have made saving for college a little less painful. The interest earned on U.S. savings bonds used to pay college or vocational school tuition and fees is now tax-exempt. The new rule applies to EE bonds purchased since Jan. 1, and, as usual, certain restrictions apply.

"For the bulk of people who want to save for college, this is a very good way," says Christopher S. Brettner, a financial planner with the Pennsylvania Financial Group in Tampa. "In these complicated times, simplicity is a very valuable feature in an investment."

Apparently a lot of people agree, because savings bond sales were up 38 percent in January compared to the same month a year ago.

To qualify for the interest exemption, a bond must be issued in the name of the parent, not the child.

Bond owners, who must be at least 24, then can use their bonds to pay tuition and fees for themselves, their spouses or their dependent children age 23 or younger. The bonds don't have to be designated for education at the time of purchase. Bond owners are free to cash their bonds at any time and use the money for any purpose, they just don't get the tax exemption if the money is not used for higher education.

The full exemption is available to single persons with incomes below $40,000 and married couples with incomes below $60,000. A partial exemption is available to single persons with incomes between $40,000 and $55,000 and couples with incomes between $60,000 and $90,000. The income levels will be adjusted for inflation each year.

Parents who don't qualify for the tax exemption because their incomes are too high can buy bonds in the child's name. The interest earned can be reported each year or deferred until it can be taxed at the child's tax rate rather than the parents'.

Savings bonds held at least five years pay a market-based interest rate that adjusts every six months. Since 1982, the average rate has been 8.2 percent, although it currently is only 6.98 percent. However, the rate can't drop below 6 percent, and if you avoid paying taxes on the interest, it becomes a very good deal. A 6 percent tax-exempt yield is the equivalent of an 8.33 percent taxable yield for someone in the 28 percent tax bracket.

For the first 30 months a bond is held, interest is credited on the first of each month. After that, it is credited every six months, calculated from the date the bond was issued. It is always best to redeem bonds right after the interest has been credited.

Savings bonds can be purchased at banks or through payroll savings plans, which many large employers offer.