COLLEGE SAVINGS 101

Granny's gift: a savings bond at Christmas

12/07/2009

QUESTION:
Dear Joe,

My mom likes to buy each of her grandchildren a $200 savings bond for Christmas each year. That's 10 grandchildren who range in age from 16 to 25. She feels this is a good way for them to have money for their future. She's not sure if she should continue, based on current interest rates and the fact that the grandchildren are getting older. What is your opinion?

-- Diane

ANSWER:
Dear Diane,

I think your mom is doing a wonderful thing. She has established a tradition that helps her grandchildren save for the future and at the same time teaches them about investing. A U.S. savings bond is the ultimate safe investment, with the full backing of the federal government, and it's easy to purchase. Go to the government savings bond Web site or to your local bank to buy them. And the interest that accrues is federally tax-deferred and state tax-free.

Granted, the interest rate on a U.S. savings bond purchased today is very low, but that is simply a reflection of the current economy and the financial markets. Rates on Series EE bonds are fixed at the time of purchase. However, I bonds are subject to an adjustment in rate every six months based on a measure of inflation. If your mom bought EE bonds in the past, she may want to consider switching to I bonds for future purchases, figuring that as the economy picks up, so will inflation and interest rates.

Under certain conditions, interest is excluded from federal taxes when a U.S. savings bond is redeemed and used to pay college expenses. However, this exclusion is designed for parents meeting certain income requirements and purchasing bonds in their own names. Bonds purchased by grandparents hardly ever meet those conditions. For specific information concerning the education bond exclusion, see IRS Publication 970.

Certainly, there are other alternatives your mom could consider. One is for her to make contributions to accounts in Section 529 college savings plans that can be used to help pay for each grandchild's future college expenses. She could either set up these accounts on her own or make contributions to accounts already established by the parents. However, the relatively low dollar amount, the large number of grandchildren and the fact that some of them may already have graduated from college make this a rather impractical choice. Another possibility might be for her to send her money to a deserving charity on behalf of the grandchildren.

But with $200 gifts and beneficiaries ranging in age from 16 to 25, one option shines above all others: cold hard cash. No doubt, the grandchildren could use some additional spending money, and a couple of crisp "Benjamins" is sure to elicit a big smile on each of their faces come Christmas Day. It also makes the entire process easier for your mom and the grandchildren who will no longer have to concern themselves with purchasing and redeeming the bonds, and dealing with any associated tax issues.

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