As news on I Bonds spreads, some people are looking for ways to buy more I Bonds beyond the limit of $10,000 per person per calendar year. Buying in a trust account is one way. Buying in your kid’s name, buying for your business, and buying as a gift are some other ways. We’ll cover buying in a kid’s name in this post. For background on I Bonds in general, please read How To Buy I Bonds.
Kids Can Invest Too
First of all, we’re talking about kids under 18 here. Adult children are adults. They can buy I Bonds in the same way as any other adult. If your adult children don’t have spare cash you can give them money and they can use the money to buy I Bonds (or anything else). If you’d like to buy I Bonds and then give the bonds to them as a gift, that’s buying as a gift. We cover buying I Bonds as a gift in a different post.
Kids can invest too, not only in I Bonds but also in other investments such as mutual funds, ETFs, etc. Because kids can’t legally agree to terms and conditions when they’re a minor, an adult has to open an account for them and act as a custodian. These accounts are typically called UTMA accounts, which are named after the law that governs custodial accounts: Uniform Transfer to Minors Act.
If you already have UTMA accounts for your kids and you’re just diversifying part of their investments into I Bonds, you can skip some of the discussion on whether you should open an account in your kid’s name in the first place.
Money In a Kid’s Name
Money in your kid’s name belongs to your kid. You’re only holding the money and investing on their behalf until your kid becomes an adult. Even if you gave the money to your kid to begin with, you can’t take the money back or spend it willy-nilly. You can spend money from the kid’s account but it has to be on something that specifically benefits the kid. Spending the money on their sports uniforms and equipment may be OK but not for general household expenses.
As the custodian, you can decide to invest your kid’s money in mutual funds, ETFs, or I Bonds. Once your kid becomes an adult, your duty as the custodian is over and you must turn over the investments to the kid. If they decide to blow the money on a Tesla or travel to Antarctica, that’s their prerogative.
If you’re only thinking of “borrowing” your child’s Social Security Number to buy more I Bonds, and you’ll cash out the bonds for your own spending and investments before they become an adult, don’t. When you open an account in the name of your child, you represent to the government you’re giving an irrevocable gift to your child. When you cash out the bonds, you represent to the government you’ll spend the money specifically for the child’s benefit. Making false statements to the federal government is a crime and can be prosecuted. If God forbid you also file a tax return on behalf of your child to claim the tax benefits pertaining to the child receiving interest from the bonds when you only take the money back to yourself, you’ll engage in tax fraud, which will get you into more trouble.
529 Plan Is Better for College
If you intend to use the money for your kid’s college expenses, it’s probably better to put the money in a 529 plan than a custodial account. Depending on where you live, you may get a state tax deduction or credit for contributing to a 529 plan. Earnings in a 529 plan are tax-free when the money is distributed for qualified college expenses whereas earnings in a custodial account are taxable.
When the I Bonds are in the kid’s name, the interest is still taxable even if the bonds are cashed out for their college expenses. When the I Bonds are in a parent’s name, it’s possible that the interest is tax-free when they’re used for a child’s qualified college expenses. However, many high-income parents don’t meet the qualifying income limit to make it tax-free.
If your kid is still young, money in a 529 plan can be invested in stocks for possibly better returns whereas I Bonds at current rates only match inflation. When your kid is ready to go to college, money in a 529 plan is also treated more favorably in financial aid considerations than money in a custodial account.
Kiddie Tax
If the money isn’t for college expenses but for some other expenses specifically for the kid, there are some limited tax benefits to put the money under your kid’s name as opposed to keeping it in your own name.
When you cash out I Bonds under your kid’s name (either to transfer to a custodial account elsewhere or to spend specifically for their benefit), the accumulated interest is taxable to your kid. The first $1,100 in interest income covered by the kid’s standard deduction is tax-free. The tax on the next $1,100 is at the kid’s tax rate, which starts at 10% when they have no other income. The tax on interest income above $2,200 is at your tax rate, which would be the same had you kept the money in your own name.
So the tax benefit of putting money in your kid’s name is limited to the first $2,200 in investment income. Your kid pays a blended 5% on $2,200 versus you pay at your marginal tax rate. You need to file a tax return on behalf of your kid to realize the tax savings. The kid’s tax return is relatively simple when they don’t have other income. Downloaded tax software offers five federal e-files for this purpose.
Gift Tax Form 709
Both contributing to a 529 plan for your kid and buying I Bonds in their name count as gifts to your kid. There’s an annual gift tax exclusion amount, which is $15,000 in 2021 and 16,000 in 2022. If the total gifts during the year from one specific giver to one specific recipient go above this gift tax exclusion amount, you’re required to file a gift tax return on IRS Form 709.
If you’re bumping against the annual gift tax exclusion amount between contributing to their 529 plan and buying I Bonds in their name and you’d like to avoid filing the gift tax return, consider splitting it up between two parents. Have one parent contribute to the 529 plan and have the other parent buy I Bonds.
Minor Linked Account
After considering the limitations of holding money in your kid’s name, the possibly better alternative of simply adding to their 529 plan, the limited tax benefits, and having to file a tax return for your kid, if you still want to buy I Bonds in your kid’s name, here’s how.
First, log in to your own TreasuryDirect account. Then to go ManageDirect. Find the link for “Establish a Minor Linked Account” on the right.
The fill out the required information (name, Social Security Number, date of birth, etc.). The primary bank account linked to your account is automatically linked to this Minor Linked Account for your kid.
Repeat the above if you’d like to create a Minor Linked Account for another kid.
After the Minor Linked Account is created, you go into it by clicking on the “Access my Linked Accounts” link under ManageDirect.
Then you buy I Bonds as usual in each Minor Linked Account. The purchase limit is also $10,000 per kid per calendar year.
Cashing Out
When you cash out I Bonds from a Minor Linked Account for your kid, the money goes to the linked bank account. After that, you can transfer the money to a custodial account elsewhere for some other investments for your kid or spend the money on expenses that specifically benefit the kid.
Just like cashing out I Bonds in any other account, the accumulated interest is taxable to the kid in the year you cash out. TreasuryDirect will generate a 1099-INT form but it won’t send it by mail. You’ll have to remember to come into the Minor Linked Account and download or print the 1099 form. You use the 1099 form to file the tax return for your kid.
Reaching Adulthood
When your kid reaches 18, they can set up their own TreasuryDirect account as an adult. You “de-link” in ManageDirect and transfer the bonds in the Minor Linked Account to their adult account. They’ll take over from there.
Only moving the bonds from the Minor Linked Account to their adult account in TreasuryDirect doesn’t trigger taxes. Cashing out does.
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Buying I Bonds in your kid’s name is relatively simple. The more important questions are:
- Do you want to give money to your kid in the first place, as opposed to adding to their 529 plan or keeping full control of the money in your own name?
- How much of your kid’s money should you invest in I Bonds that match inflation as opposed to in mutual funds and ETFs for long-term growth?
Remember money in your kid’s name belongs to the kid.
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Barry Dreayer says
Love your emails/articles. As a CPA, I started referring to them, especially about I bonds.
What about the strategy of not deferring interest income on the I bonds? Might that be advantageous for some kids if their other investment income is low, keeping them out of the kiddie tax?
Keep up the great work.
Harry Sit says
I’m leaving it out as an “advanced” tactic. It works in theory but it introduces a lot of complications when there are multiple purchases and redemptions. You’d have to track the accrued interest bond by bond. It’s not easy because TreasuryDirect doesn’t issue any monthly statements. You only see the current redemption value, and it’s displayed without the last three months’ worth of interest when the bond is within its first five years. You need the redemption values on January 1 with the three months’ worth of interest added back.
If a client comes to you and wants you to track and report the accrued interest on multiple bonds purchased at different times, you’d probably have to charge the client more than the tax savings. And if they go to a different CPA after they move, the next CPA may not know what you did, and it’s very easy to pay tax again on the redemption when there’s a 1099 form showing all accumulated interest.
It works if you use a spreadsheet to track and calculate interest for your own children when you don’t charge your children for your time.
Steve says
In addition to the tax differences, there could be even larger effects on financial aid. I believe Treasury bonds in the student’s name count as a student asset, and the FAFSA calculations would expect the student to contribute 20% of their assets to their own education. Typically 529s are held in the parents’ names and are only expected to be used up at a rate of 5.64% per year.
Tony says
When buying I Bonds in linked minor account, what should I put in ‘registration’?
my kid’s name as sole owner? or my name and my kid’s name as co-owners?
Harry Sit says
The kid has to be the primary owner in the minor linked account. As the custodian, you have access to the minor linked account to buy or cash out bonds even if the bonds have your kid as the sole owner. Appointing yourself or another person as the second owner or the beneficiary affects what happens if the kid dies.
Vic says
When redeeming I bonds in a minor linked account (after the initial one year hold period) and before the kid becomes an adult, will the redeemed amount be deposited back to the parents bank account? If so, what’s the risk/downsides of buying I bonds in the child’s name and redeeming back to the parents bank account?
Harry Sit says
When you open the minor account, you represent to the government that the money belongs to the child and you’re only managing it on your child’s behalf. When you redeem the bonds, you represent to the government that the money will be used specifically for the child’s benefit (or transferred to another custodian account for the child). Making false statements to the federal government is a crime.
calwatch says
This is viable if you know your kid is going to private primary or secondary school, though. The 529 limit is only $10,000 a year for private school and many states don’t treat private school as advantageous as they do college for their 529’s – California even charges the same penalty for early withdrawal as for non qualified expenses. Although I don’t think it’s worth the benefit, people do send their children to private school for religious or cultural reasons and this would cover it.