A savings bond or 529 contribution probably won’t be the gift that gets the most attention on Christmas morning, but it just might end up being the one that is most appreciated. Parents, grandparents and other interested adults can give financial gifts to children that can help secure their futures, whether it’s saving for a first car, college or a down payment on a house.
Sam Davis, partner/financial advisor with TBH Global Asset Management, points out that financial gifts have merit beyond the obvious monetary rewards. “Parents and grandparents should consider making financial gifts because they can help children achieve something that would otherwise not be possible,” explains Davis. “This can include things like medical school, which has now become unaffordable for many, or helping a child get through a short-term, hard financial situation. It can also include, however, things like trips around the world, which can help better a child's understanding of global dynamics.”
Whether your financial gift helps a child pay for college, travel across Europe for the summer or spark an interest in saving and investing, your child or grandchild will thank you because, as Davis notes, “You are personally invested, physically and financially, in the things that are important to them.”
Savings bonds make excellent financial gifts, because they can grow steadily by earning interest. Treasury securities are types of debt instruments that include Treasury bills, notes, bonds, Treasury inflation-protected securities (TIPS) and savings bonds. Most Treasury securities are called “marketable” securities, because they can be bought and sold in secondary markets after they are purchased from the Treasury. Savings bonds differ from other Treasury securities in a few ways:
- Savings bonds are “non-marketable” and therefore cannot be traded on a secondary market;
- Savings bonds can be owned by kids; and
- Savings bonds are available for purchase as gifts.
The money you pay for a savings bond represents a loan to the U.S. government. In exchange for the loan, the savings bond continues to earn interest for up to 30 years. Any time after 12 months, the savings bond can be redeemed for its face value, plus any interest it has earned; however, if the bond is redeemed before it is five years old, you will forfeit the last three months’ interest.
Savings bonds are available as Series EE or Series I bonds, both of which accrue interest monthly and compound interest semiannually. The biggest difference between the two is the interest rate you receive. Series EE bonds issued on or after May 1, 2005 earn a fixed rate of interest. The interest rate of Series I bonds is based on both a fixed rate of return and a variable semiannual rate, indexed for inflation. To reward long-time bondholders, EE bonds are guaranteed to double in value from their issue price no later than 20 years after their issue date.
You can purchase a digital savings bond as a gift through the TreasuryDirect website, a secure, web-based system operated by the U.S. Department of the Treasury. Although the process is a bit more complicated than it used to be when you could purchase paper savings bonds with the help of financial institutions, here are the basics for buying digital savings bonds:
- Go to www.treasurydirect.gov
- Log into your TreasuryDirect account (or open one in your name)
- Purchase the type of savings bond you wish (Series EE or Series I), in the desired denomination ($25 to $10,000)
- Deliver the savings bond gift to the recipient’s TreasuryDirect account
- Print out a gift certificate to give to the recipient
You will need to know the recipient’s legal name, Social Security number and TreasuryDirect account number. In order for an under-18 child to receive a savings bond as a gift, the child’s parent or legal guardian must set up a Minor Linked Account within his or her own TreasuryDirect account. If the child’s parent/guardian does not set up an account (for whatever reason), you can still buy the bond, hold it in your own account’s “Gift Box” and transfer it at a later date.
The reason you need to provide the child’s Social Security number is that the bond applies to the recipient’s annual bond purchase limit – not yours. The annual purchase limit for savings bonds is a combined $10,000 in Series EE electronic bonds, $10,000 in Series I electronic bonds and $5,000 in paper Series I bonds.
It’s no secret that post-secondary education is expensive. College costs are increasing at about two times the rate of inflation each year, and the trend is expected to continue. According to the College Board, the average cost of tuition and fees (not including room and board) for the 2015-2016 school year was $9,410 for in-state public colleges, $23,893 for out-of-state public colleges and $32,405 for private not-for-profit colleges.
Fast forward a decade and you can expect to pay:
- $13,929 per year for an in-state public college
- $35,367 per year for an out-of-state public college
- $47,967 per year for a private college
Tip: Want to see an estimate of how much it will cost to send your child or grandchild to college? Use Colleges Savings Plans Network’s College Cost Calculator.
“One of the best ways to help a child financially while limiting your own tax liability is the use of 529 college plans,” explains Sam Davis, partner/financial advisor with TBH Global Asset Management. 529 College Savings Plans are tax-advantaged plans that allow families to save for future college expenses. These are typically state-sponsored investment plans, and each state has different requirements and benefits, including tax advantages. There are two types of 529 plans: savings and prepaid plans.
- 529 Savings Plans – These plans work similarly to other investment plans such as 401Ks and IRAs in that your contributions are invested in mutual funds or other investment products. As a state-sponsored investment plan, the state coordinates with an asset management company (such as Vanguard) to handle the investment according to the state's plan features. The owner of the account (i.e. the parents) deals directly with the asset management firm, rather that with the state. The beneficiary (your child or grandchild) is the person for whom the account is set up and who will use the money for college.
- 529 Prepaid Tuition Plans – Prepaid tuition plans, also called guaranteed savings plans, are administered by states and higher education institutions. They allow families to plan for future college expenses by pre-paying tuition, locking in today's tuition rate and the program pays future college tuition at any of the state's eligible institutions. If the student goes to an out-of-state or private college or university, an equal amount of money is distributed.
“I strongly advise my clients to fund 529 plans for the unsurpassed income tax breaks,” says Davis. “Although the contributions are not deductible on your federal tax return, your investment grows tax-deferred, and distributions to pay for the beneficiary's college costs come out federally tax-free. Rules for 529s do vary by state and I would encourage everyone to understand their state’s rules. For example, your own state may offer some tax breaks, as well (like an upfront deduction for your contributions or income exemption on withdrawals) in addition to the federal treatment.”
Savings bonds and 529 contributions are just two of many different financial gifts that are appropriate for kids. You can also consider giving:
- Stocks – You can transfer stock you already own, or you can purchase individual shares through an online brokerage that supports stock gift giving (such as ShareBuilder or OneShare).
- IRA Contributions – If the child has earned income from a job, you can fund his or her annual contribution, up to the allowable amount.
- Cash – Cold hard cash is always a welcome gift, but it might be most effective if it is money earmarked for a specific purpose, such as paying for a car, summer camp or to pay down an adult child’s debt (such as student loan or credit card debt).
- Financial Advice – A trip to a qualified financial planner can help even young children understand the value of money, savings and investing.
Money aside, Davis notes that the single best financial gift you can give a child is mentorship. “The most important thing you can give your child is the ability for them to view and watch you make good financial decisions over the course of your life,” says Davis. “If you are not teaching them about investing and how to save a portion of their income every month then you are doing your child a great disservice.”
Mentorship has a positive effect on the child’s lifelong financial literacy, as Davis points out, “We are currently seeing a lot of wealth transfer (money moving from one generation to the next) and many of the individuals inheriting money have little to no understanding of investments and how to manage the inherited money. They do know how to spend it!”
The Bottom Line
For 2016, you can give up to $14,000 per year ($28,000 if you and your spouse give together) to as many people as you want, without any tax consequences to you. Because tax laws are complicated, Davis encourages families to work with qualified tax professionals. “Engage your tax advisor on a deep level,” Davis recommends. “I would encourage each family to identify the value of their current tax professional and understand if that individual is truly looking out for ways in which they can legally save on their taxes. Generally speaking, families assume that they're taking advantage of every opportunity, and many times that assumption is unfounded.” A front-seat approach can ensure that your family can bestow financial gifts while at the same time minimizing tax consequences.