U.S. Savings Bond Education Tax Exclusion — Section 135

U.S. Series EE and Series I savings bonds earn interest that is normally taxable for federal income tax purposes (though state and local taxes never apply). Under 26 U.S.C. § 135, taxpayers who redeem qualifying savings bonds and use the proceeds to pay for qualified higher education expenses can exclude the bond interest from income — a tax benefit designed to encourage savings for college. The exclusion is available for bonds purchased after 1989 and applies to tuition and fees at eligible educational institutions (but not room and board). It is subject to income limits that phase out the benefit at higher income levels — as of 2026, the phase-out begins for modified AGI above $96,800 for single filers and $145,200 for married filing jointly (2026 figures, inflation-adjusted annually). For many families, the exclusion is partially or fully phased out unless they planned ahead and keep income low in the redemption year. The § 135 exclusion is one of the oldest federal education tax incentives, predating the education tax credits, 529 plans, and Coverdell ESAs that now dominate college savings planning.

Current Law (2026)

Legal Authority

• 26 U.S.C. § 135(a) — General rule: gross income does not include interest received from qualified United States savings bonds (Series EE or I) if the taxpayer pays "qualified higher education expenses" during the year the bonds are redeemed, to the extent provided under this section
• 26 U.S.C. § 135(b) — Limitations: the exclusion is limited to the ratio of qualified expenses to total proceeds (if expenses are less than total redemption proceeds, only the proportionate share of interest is excluded); the exclusion is reduced if modified AGI exceeds the phase-out threshold
• 26 U.S.C. § 135(c) — Definitions: "qualified United States savings bond" means Series EE bonds issued after 1989 or Series I bonds; the bond must be in the name of the taxpayer (or joint name with spouse); "qualified higher education expenses" means tuition and fees required for enrollment at an eligible educational institution (any accredited college, university, vocational school, or other postsecondary institution eligible for federal student aid programs), reduced by scholarships, grants, and other excludable assistance
• 26 U.S.C. § 135(c)(2)(C) — Contributions to 529 plans or Coverdell ESAs count as "qualified higher education expenses" for § 135 purposes, allowing taxpayers to redeem bonds and roll them into a 529 without triggering income tax on the interest
• 26 U.S.C. § 135(d) — Special rules: (1) if married, must file jointly to claim the exclusion; (2) the bond owner must have been 24 years old at the time of issuance (preventing purchase in a child's name); (3) MAGI for the phase-out adds back the excluded interest itself and student loan interest deductions

How It Works

Series EE bonds (electronic bonds sold at face value; formerly paper bonds at half face value) and Series I bonds (inflation-indexed, sold at face value) both qualify for the § 135 exclusion if purchased after December 31, 1989 — older Series E and Series HH bonds do not. The bond must be registered in the taxpayer's name (or the taxpayer's and spouse's name); bonds registered in the child's name alone do not qualify even if the proceeds pay for the child's education. To prevent parents from registering bonds in a child's name to capture the exclusion, § 135 requires the bond owner to have been at least 24 years old on the first day of the month the bond was issued — a bond issued to a 22-year-old won't qualify for the exclusion even decades later. If total redemption proceeds exceed qualified education expenses, only a proportionate share of the interest is excluded: redeeming $12,000 to cover $9,000 of tuition means only $9,000/$12,000 × the interest portion is excludable; the rest is taxable. To get the full interest exclusion, qualified expenses must equal or exceed the total redemption amount.

One underused planning strategy: redeem bonds and contribute the proceeds to a 529 education savings plan in the same year — the 529 contribution counts as a "qualified higher education expense" for § 135 purposes, allowing the interest exclusion even though the 529 funds won't pay tuition until future years. The income phase-out reduces the exclusion dollar-for-dollar above the threshold: for 2026, the exclusion begins phasing out at approximately $96,800 (single) and $145,200 (married filing jointly), with complete elimination at roughly $111,800 and $175,200 respectively. The MAGI calculation for § 135 purposes adds back the excluded interest itself, creating a circularity that requires careful calculation. One significant limitation: room and board — often the largest single expense at a residential college — does not count as a qualified higher education expense for § 135; only tuition and required fees qualify, making the exclusion much less valuable for families at residential colleges than at commuter or community colleges.

How It Affects You

If you own Series EE or I bonds and have a child approaching college age: Check whether the income phase-out limits apply to you. If your MAGI is below $96,800 (single) or $145,200 (married), you may be able to exclude the bond interest from income by redeeming the bonds in a year when you pay tuition. Consider timing bond redemptions carefully: if your MAGI is just above the phase-out threshold in some years (due to bonuses, capital gains, etc.), plan redemptions for lower-income years. Also consider the 529 rollover strategy — contributing bond proceeds to a 529 in the same year gives you the interest exclusion and future tax-free growth.

If you're saving for college for a young child: Series I bonds (inflation-indexed, with the 2024-2025 composite rate varying with inflation) remain attractive for near-term college savings given their inflation protection and the § 135 exclusion. But they must be purchased in the parent's (not child's) name to qualify. Bonds have a 1-year holding requirement before redemption and a 3-month interest penalty for redemption within 5 years — plan accordingly for when tuition bills will arrive. For longer-term savings (10+ years out), 529 plans with equity exposure may outperform bonds but lack the safety and simplicity of savings bonds.

If you already have savings bonds: Track the purchase dates and face values on TreasuryDirect.gov. Know your basis (what you paid, since interest accrues over time and partial reporting elections can be made). Before redeeming, estimate whether your income that year will be within the phase-out range and whether you'll have qualifying educational expenses.

If you're a high-income family: The income phase-out likely eliminates or severely curtails the § 135 exclusion for you. At MAGI above approximately $111,800 (single) or $175,200 (married), the exclusion is completely phased out. Focus instead on 529 plan contributions, which have no income limits and provide tax-free growth and distributions for qualified education expenses — a more powerful education tax benefit for high-income families.

State Variations

Series EE and I bond interest is exempt from state and local income taxes regardless of whether the § 135 federal exclusion applies — this is a general rule for U.S. government obligations that applies under the Public Debt Act. The § 135 exclusion provides an additional federal benefit on top of the permanent state/local exemption. From a state tax perspective, savings bond interest is never taxable, making the comparison with 529 plans (state tax deductibility for contributions in 34 states) more nuanced.

Pending Legislation

• Expanding eligible expenses: Proposals to include room and board, student loan repayment, and other education costs in the § 135 definition of "qualified higher education expenses" have been introduced but not enacted.
• Income limit increases: The phase-out thresholds are inflation-adjusted annually under existing law. No legislation to fundamentally change the structure (e.g., eliminating the phase-out entirely) has advanced.

Recent Developments

Series I bonds attracted enormous public attention in 2021-2022 when their composite rate exceeded 9% (reflecting high inflation), making them one of the best-returning investments available for risk-averse savers. Many families who purchased I bonds at that time may now have significant savings bond positions that will mature as their children approach college age, making § 135 planning newly relevant for a large cohort of bond holders. TreasuryDirect.gov has streamlined the process of tracking bond values and redemptions, making it easier for holders to plan § 135 elections. The IRS has also clarified that contributions to an ABLE account (§ 529A, for individuals with disabilities) count as qualified expenses for § 135 purposes, expanding the rollover options for families with special needs planning considerations.

• I bond rates fell sharply from 2022-2023 highs: The composite rate dropped to roughly 3–4% by 2025 as inflation moderated; families who bought I bonds at 9%+ peak rates now face reinvestment decisions as those bonds eventually mature, and the § 135 exclusion becomes relevant when proceeds fund college costs.
• 2025 MAGI phase-out thresholds (inflation-adjusted annually): the exclusion phases out between $96,800–$111,800 (single) and $145,200–$175,200 (joint); dual-income households near these limits should model redemption timing carefully against income fluctuations.
• OBBBA (2025) does not directly modify § 135, but proposed changes to student loan deductions and education credits in the reconciliation bill could shift the relative value of savings bond exclusion planning versus other college savings vehicles.