Buying U.S. Treasury Bonds for College Accounts

A Guide to the Safety, Interest Rates, and Tax Rules of U.S. Treasury Bonds

No other investment offers the promise of long-term safety and a competitive yield like the 30-Year U.S. Treasury Bond. These bonds (just like T-Bills and Notes, Savings Bonds, and GNMA's) are backed by the "full faith and credit" of the U.S. Treasury. In other words, the only way an investor who holds these bonds to maturity would not receive their semi-annual interest payments and eventual return of principal, is if the U.S. Treasury itself were to go bankrupt.

In addition to the safety offered by the 30-Year U.S. Treasury Bond (also known as the "long bond"), the interest earned by investors is exempt from state income tax. This can make the 30-Year Treasury Bond competitive with other higher-risk bond issues.

U.S. Treasury Bond Maturities

U.S. Treasury Bonds are initially issued with only 30-Year maturity dates. However, these bonds are actively traded in the "secondary market" between private investors. This means for example, that it is possible to purchase a 30-year Treasury Bond with only 27 years remaining.

U.S. Treasury Bond Prices

Newly issued 30-Year U.S. Treasury Bonds are sold in minimum increments of $100, with $100 also being the minimum purchase amount. The U.S Treasury may also, from time to time, "reopen" or sell additional amounts of a previously issued Treasury Bond issue.

In both of these cases, a $100 bond may sell for slightly more or less (known as a premium or discount) to adjust for interest rate changes at time of auction.

Purchasers may also be required to pay "accrued interest" if they can expect to receive a full-interest payment for a period in which they only owned the bond for a portion of the time.

U.S. Treasury Bond Interest Rates

Most parents buying U.S. Treasury Bonds for college or other expenses will be buying them using a non-competitive bid.

In other words, they're not buying a large enough amount to directly influence the pricing and yield of the bonds. Investors purchasing under a non-competitive bid have a rough idea of what their interest rates will be prior to purchasing the bond, though it usually fluctuates slightly.

Interest on U.S. Treasury Bonds is paid every six months and is typically deposited to an investor's TreasuryDirect or brokerage account.

Taxes on U.S. Treasury Bonds

The interest earned on U.S. Treasury Bonds is subject to Federal income taxes, but exempt from state and local incomes taxes. This means that Treasury Bonds are increasingly attractive to investors in states with high income tax rates.

Unlike U.S. Series I and EE Savings Bonds, there is no special tax treatment for 30-Year Treasury Bond interest or sales when done to help pay college tuition.

Buying U.S. Treasury Bonds

U.S. Treasury Bonds can be bought directly from the U.S. Treasury through the TreasuryDirect system, through banks and brokerage houses, and through payroll deductions.

U.S. Treasury Bonds as a College Savings Strategy

There's one primary caution for parents considering the use of 30-Year Treasury Bonds as a college funding vehicle: Most of our children will be in college in just 18 years or less!

While the higher rates of the 30-Year bond are attractive, it can come back to haunt parents who have to sell these bonds prior to their maturity date to pay tuition.

Depending on the prevailing interest rates at the time of an early sale, a parent may actually have to sell their bond at a discount in order to attract a buyer.

Parents wanting to own government bonds for their children may be better served to look at Series EE or I Bonds, T-Bills, Treasury Notes, or even GNMA's.