What Kind of Savings Bond Do You Buy a Newborn?

Stuffed animal, onesie or savings bond? If that’s your dilemma when deciding on a baby gift, it’s really a no-brainer. That tiny bundle of joy doesn’t care what he receives, but parents hope their infant will eventually go to college, and it’s never too early to start saving. While the paper bonds of the past are no longer available (with one exception), buying them online via Treasury Direct, the Treasury Department’s electronic service, is even easier than purchasing them from your local bank. Banks will still redeem electronic savings bonds at maturity.

These days, there are only two types of savings bonds available, and one makes more sense as a newborn gift than the other. Series EE bonds are not protected against inflation, but Series I bonds are. The EE bonds earn a fixed rate of interest, which you will know at the time of purchase. The interest rate for I bonds is a combination of a fixed rate and an inflation rate, with the latter determined on a semiannual basis. The inflation protection makes the I bond a better choice overall for a newborn, since she won’t use the bond for at least 18 years to pay for higher education. Both types of bonds are purchased at face value. The old paper EE bonds were sold at half of face value.

EE bonds mature in 20 years but continue to pay interest for another 10 years. I bonds mature at 30 years, but if the bond is redeemed within any period after the first five years, the recipient receives the full face value plus accrued interest. For either series, the annual limit on bond purchases is $10,000.

To purchase a bond through Treasury Direct, you must have an account and so must the child’s parents. You must include the recipient’s full name and Social Security number or taxpayer identification number when making the purchase, along with his Treasury Direct account number. You must make the newborn a beneficiary of the bond, not the owner. You’ll also need to get the newborn’s Social Security number from the parents. It takes up to five days for the gift to appear in the recipient’s account.

If you want to purchase an old-fashioned paper bond and give it directly to the parents, you can do so with an I bond via your income tax refund. You can purchase such bonds in the name of another individual, so buy the bond in the name of the parent with the child as beneficiary, not co-owner. If you do go the paper route, keep in mind that paper I bonds are available starting at a $50 minimum investment, with denominations continuing at $100, $200, $500 and $1,000. You may use up to $5,000 of a refund to purchase Series I bonds annually.

Both types of bonds are exempt from state and local taxes. When used for qualified education expenses, savings bonds are also exempt from federal taxes. One caveat is that married couples must file jointly to receive the exemption. Higher education expenses must occur the same year as the bond redemption. While qualified expenses include tuition and fees at an institution of higher learning, the use of savings bonds for room and board or books is not considered a qualified expense for exemption purposes. Income limits also come into play for the federal tax exclusion. The income limit will depend on the amount at the time of redemption.

For obvious reasons, many parents do not want to give their Social Security numbers or those of their children to most people, with the possible exception of a close family member. That doesn’t mean you need to buy a stuffed animal as a gift instead. Ask the parents about contributing to a child’s 529 education savings plan. While such plans are not as safe as savings bonds because they may include stock as investments, they are also federally tax-free when used for qualified education expenses.