Q. My parents have purchased savings bonds for my kids’ for college, which was very nice, but I think there might be better investments for them. The kids are 4 and 2. What should I do?
A. The gesture was very nice, indeed, but savings bonds are not necessarily the best choice for college savings.
Series EE bonds purchased today will earn a fixed rate of return, said Amanda Lott, a certified financial planner with RegentAtlantic Capital in Morristown.
The current rate through April 30, 2015 is 0.10 percent. You can check updated rates at www.treasurydirect.gov.
“They are an accrual-type security, meaning that interest is added to the bond monthly and paid when you cash in the bond, which can be for up to 30 years,” Lott said. “You can no longer buy paper EE bonds. You can only buy electronic bonds.”
Lott said electronic bonds are sold at face value. You’d pay $25 for a $25 bond. But the paper bonds were sold at half the face value. You’d pay $25 for a $50 bond, but these are no longer available.
“The minimum retention period for a Savings Bond issued after Jan. 31, 2003 is 12 months,” she said. “This is the amount of time that you must wait before you can redeem the bond.”
If you redeem the bond before you’ve owned it for five years, you forfeit the three most recent months’ interest, Lott said. If you redeem it after five years, there are no early redemption penalties.
Also, in the tax year that bond is redeemed, taxes on the accrued interest become due — or in the year of maturity, whichever comes earlier, she said.
“Because we are in a low interest rate environment, savings bonds are not a great investment today, particularly for young people who have a longer time horizon and can afford to have exposure to the volatility of the stock market,” Lott said.
For children of your age, a 529 Plan is the more common investment recommendation.
A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs, said Alan Meckler, a certified financial planner with Cornerstone Financial Group in Succasunna. The plans are named after Section 529 of the Internal Revenue Code, which created these types of savings plans in 1996.
“529 Plans can be used to meet costs of qualified colleges nationwide,” Meckler said. “In most plans, your choice of school is not affected by the state your 529 savings plan is from. When you invest in a 529 plan, you would typically be the owner and your child would be the beneficiary.”
All withdrawals from 529 plans for qualified education expenses will remain free from federal income tax, Meckler said. And all of the earnings from the plan will be distributed federally income tax-free.
Many states mirror the federal tax advantages for 529 plans by offering state tax-deferred growth and tax-free withdrawals for qualified higher education expenses, he said. Withdrawals for other than educational expenses may be subject to taxation.
“Each state that offers a 529 plan determines how its plan is structured and which investment options are offered,” Meckler said. “While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as a state tax deduction, a matching grant, and scholarship opportunities, protection from creditors and exemption from state financial aid calculations, for investors who invest in 529 plans offered by their state of residence.”
Unfortunately, New Jersey’s plan doesn’t offer much of an advantage.
Your 529 plan can be invested in an age-based allocation, meaning that the older that your child becomes, the more conservative the account will become, Lott said. For example, it will have more bonds and fewer stocks as the child approaches college age.
“If your parents plan on future gifts to your children, you could tell them that you’ve opened 529s in their names and that any gifts to those accounts would help with your goal of funding college education for them,” Lott said. “Even if the funds aren’t utilized for higher education expenses, the only downside is that any earnings withdrawn from the account will be subject to income tax and a 10 percent penalty.”
Knowing that the 529 would likely beat the 0.10 percent rate of a savings bond, Lott said, this would likely still be a better investment choice.
“Also, a 529 is a beautiful thing because you can be the owner and your child can be the beneficiary,” she said. “Although all gifts are considered to be made to the beneficiary, you are the owner and maintain complete control over the account. That way, you don’t have to worry about little Johnny utilizing the funds in a way that Grandma and Grandpa would disapprove of.”
Logistically speaking, Lott said a parent may redeem a child’s bond if the child is too young to sign the request for payment and if the child lives with the parent or the parent has been granted legal custody.
“The financial institution may then pay the money to the parent,” she said. “This is if the bond is a paper bond. If it’s an electronic bond, it will be in a minor’s account linked to the custodian’s online TreasuryDirect account.”
She said you can log in, go to the linked account for the minor, and follow the directions there for a redemption.
Good luck in your long-term savings goals!
Email your questions to moc.p1498219285leHye1498219285noMJN1498219285@ksA1498219285.