Baccalaureate Bond

A baccalaureate bond, also known as a state tuition bond, is a zero-coupon bond issued by certain states to assist families in saving for college tuition by means of a tax-free investment. A zero-coupon bond is a debt security that doesn't pay interest, also known as a coupon,  but is traded at a deep discount, generating profit at maturity when the bond is redeemed for its full face value.

Baccalaureate bonds are tax-free securities that allow states to lend at reasonable rates, while issuing tax-free bullet bonds to residents who wish to save over time for post-secondary expenses, namely tuition. Bullet bonds are debt instrument whose entire face value is paid at once on the maturity date.

Baccalaureate bonds are typically issued in small denominations and are offered in several different maturities. These features make the bonds more convenient for investing and for paying annual college tuition bills. In some states, additional benefits such as tuition discounts may be included if the student enrolls in a state college using these bonds for payment. When combined with other tax-advantaged college savings tools, such as a 529 Savings Plan, baccalaureate bonds can be an efficient way of saving toward post-secondary education.

Like U.S. savings bonds, baccalaureate bonds are sold for less than their face value and are heavily discounted. They also earn a high level of interest, but they pay no interest until they reach their maturity date. Because most undergraduate programs are four years in length, it may be a good idea to stagger the maturities of baccalaureate bonds, so that the bonds will be maturing when the student needs the money most.

Approximately 20 states still issue baccalaureate bonds. The bonds are usually available in cost increments between $1,000 and $5,000, and have maturities between five to 20 years. To qualify for these state-issued bonds, a student must be a resident of the state, and use the proceeds of the bond to pay for tuition at an in-state college or university.

The earnings on baccalaureate bonds accumulate free of state, local, and sometimes federal income tax, assuming you are a resident of the state and use the bonds to pay for tuition at a qualified in-state, post-secondary institution. Also, there are no limits on one’s adjusted gross income, or AGI, to qualify for the bonds. AGI is a measure of income calculated from your gross income and used to determine how much of your income is taxable. It is the starting point for calculating your tax bill and, among other things, is the basis for many deductions and credits.