What it is:
A baccalaureate bond is a state-issued bond that helps families save for college.
How it works (Example):
For example, let's say Family X wants to save $100,000 for college. They live in a state that issues baccalaureate bonds.
To take advantage of the program, they purchase $50,000 of bonds on their son's first birthday. The bonds, which are zero-coupon bonds and thus provide no interim interest payments, mature at their $75,000 face value when their son turns 18. The boy's grandparents also buy baccalaureate bonds in small denominations over the years, amounting to another $25,000 in face value.
When the boy is ready to attend college, the parents apply the proceeds from the bonds to tuition, generally tax-free.
Why it Matters:
Baccalaureate bonds are another way to save for college, though not all states offer them. Because the bonds are issued by a state, the risk of default is low. And because many state issuers also provide tuition discounts, parents and students are able to save considerable amounts of money with several advantages. However, states may require participants to be residents of the state, and they may require the participants to apply the proceeds to state university.