When we were kids, there was no birthday gift that was more disappointing than a savings bond. It was nice to see that the bond would be worth US Dollars 100, but to have to wait five to seven years to redeem it seemed like an eternity. As a parent, however, you might want to consider buying bonds for your child's education since you may be able to exclude the interest earned from taxes if you use the proceeds to pay for qualified educational expenses.
Eligible bonds are series EE bonds issued on January 1990 and later, along with all Series I Bonds. To cash in the bonds tax-free you must have been at least 24 years old when you purchased them, and the bonds must be registered in your name or your spouse's name. Your child can be listed as a beneficiary but not as a co-owner. You must also meet specific income limits. For the 2008 tax year your modified gross adjusted income must be less than US Dollars 67,100 if you are filing single and less than US Dollars 100,650 if you file jointly. If you make more than this amount your tax benefits will be reduced. If you earn more than US Dollars 82,100 as a single filer or US Dollars 130,650 as a joint filer you cannot deduct any interest.
Unfortunately, savings bonds given to your child as a gift aren't eligible for tax-free treatment. Also, any bonds not purchased by you are similarly ineligible. However, if you meet the criteria all you need to do is file form 8815 to figure your education savings bond interest exclusion.
For a long time the Uniform Transfers/Gifts to Minors Acts were the main way parents and grandparents transferred money to a child. With money put into custodial accounts, children under the age of 18 can keep the first US Dollars 850 in unearned income tax free and pay at their tax rate for the next US Dollars 850. This also applies to children up to age 23 if they are full-time dependent students.
With the advent of 529 Savings Plans and the increased contribution limits to the Coverdell ESA, you now have an alternative to transfer money totally tax-free. The only limitation is that the money must be used to pay for educational expenses. If you want to help your child save for a down payment on a house or any non-education related uses, then UGMA/UTMA may still be the best option.
One additional potential advantage of transferring money with a 529 Plan is that the money stays in your control. With a custodial account (and even Coverdell ESAs) the money becomes the property of the child at age 18 or 21, depending on your state's laws. Also, 529 Plans are considered the property of the contributor, which is usually the parent, while custodial accounts are the property of the student, which means that money will have a greater negative impact on the size of any financial aid package.
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