Money Management Q&As

April 8, 2005

Savings bonds and tuition; easy pension; excess escrow; vacation home.

Using savings bonds to pay tuition feesQ. If we redeem some US savings bonds we've owned since 1990 and use the money for our son's college expenses, will we owe tax on the accumulated interest?

A. You may be able to exclude some of it if your modified adjusted gross income for 2005-including the bond interest and certain other items-is below $121,850. For example, suppose you paid $15,000 in tuition fees (or contributed that amount to a 529 savings plan) in 2005 and your bonds' redemption value is $20,000, of which $8,000 is interest. The maximum exclusion would be 15,000/20,000 times $8,000, or $6,000. If your married filing jointly, modified AGI is more than $91,850, the exclusion gradually phases out, vanishing completely at $121,850. The figures are lower for singles and heads of household. Form 8815 will help you with the arithmetic.

Keep in mind also that the bonds must be held by you alone or with your spouse, but not with your child. In totaling expenses, don't count payments for room and board or any for which you claim a tax benefit under other provisions of the law, such as a Hope credit.

A. Assuming you die before your pension distributions start, the entire fund must generally be liquidated within five years if the plan beneficiary is a trust. By contrast, designating your children as individual plan beneficiaries allows the payouts to be spread over their lifetime, so earnings on the fund's remaining assets continue to be tax-sheltered. However, you can preserve the tax benefits even with the trust, provided it becomes irrevocable at your death and specifies that your children are to get the payments. You must also give their names to the plan administrator and agree to furnish a copy of the trust document on request and notify him of future changes.

An easy way to run a pension plan Q. I want to set up a simplified employee pension plan (SEP) for my practice, but I dread getting bogged down in paperwork. Can I really keep it simple?

A. Yes. The best way is to use the model SEP agreement (Form 5305-SEP) developed by the IRS and available at http://www.irs.gov. You must give the participants a copy of the filled-out form, but you don't have to file it or anything else with the IRS. Your contributions go directly into an IRA established by each employee with a bank or other approved financial institution, which reports annually to the IRS. To be eligible to adopt the model SEP, your practice must not maintain any additional qualified plan.

Help when you swap real estateQ. I could sell two of my rental properties at a tidy profit, but I'd rather exchange them for a single property with the same total value. Then I wouldn't owe tax on my gain until I dispose of the replacement property later on. Trouble is, the property owner I'm dickering with won't agree to a two-for-one deal and insists on cash instead. Is there a way out?