If I buy I bonds for my grandchild, will they be tax free?

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Q. I’m thinking about buying I bonds to help finance my two-year-old grandson’s education. The I bonds would be purchased in his name and Social Security number and held in trust in his mother’s Treasury Direct account until he’s 18 years old. The website has a list of requirements that must be met so the owner of those bonds could exclude the interest accrued if the proceeds are used to fund higher education expenses, one being that the owner of those bonds must be 24 years old or older when the bonds were issued. So would he have to pay tax on the bonds?
— Gramps

A. Your grandson is lucky to have you helping with his future education costs.

And we see why I bonds are attractive, paying nearly 10% now.

In this case, the age of the bond purchaser matters.

Buying the bond in your grandchild’s name would disqualify the interest from being tax-free because he is under 24 years old, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette.

Maye said even if a grandparent purchases the savings bond in their own name, the interest still wouldn’t be tax free unless the grandchild is a dependent on their income tax return.

“One workaround is the grandparent buying their adult child a savings bond as a gift,” he said. “The parent could then use the savings bond to pay for the grandchild’s education tax-free, assuming the parents met all the other qualifications, including the income limitation.”

However, Maye said, is in this case the parent would be the owner of the bond. It would be theirs, for better or for worse.

“They can cash it in and use it for a vacation,” Maye said. “Also, it would be fair game in a divorce or creditor issue situation as well.”

Buying the savings bond in the child’s name is probably not a good idea from a financial aid planning perspective, Maye said.

“Assets in the child’s name are considered a child’s asset on the FASFA form and counted at a higher level than parental assets,” he said.

But non-parental assets such as those owned by a grandparent are not counted until they are drawn upon, he said.

Instead, he said, a grandparent can set up a 529 plan that they own for the benefit of their grandchild.

“As a non-parental asset, it is not counted as an asset on financial planning forms,” he said. “It will be counted once the 529 is being drawn upon, which is why 529 is best used in the final year of school when there will be no impact as no FASFA is prepared the following year.”

Maye called a 529 plan a powerful tool because the proceeds are tax-free if used for qualified educational purposes.

Plus, he said, the beneficiary can be changed from one grandchild to another should plans change in the future.

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This story was originally published on July 15, 2022.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.