Savings Bonds vs. a Custodial Account

by Linsay Evans

Custodial accounts provide the means to invest or save for an individual under the age of 18, or for other individuals within your custody, including retirement accounts for employees. Custodial accounts can be used to manage future payment rights, such as those from pensions, insurance policies and profit-sharing plans. They can contain money, securities, stocks, savings accounts or certificates of deposit, as well as U.S. savings bonds.

Savings Bonds

The U.S. Treasury issues savings bonds in order to raise funds. When you buy a savings bond, you are essentially lending money to the federal government. In turn, the government pays you interest in exchange for the use of your money. Savings bonds are registered securities, as they are issued specifically to an individual whose name is registered as the owner or beneficiary of the bond. A bond may be registered to a single owner, who is the only person who can redeem it, or to co-owners, who may redeem the bond without express consent of the other co-owner. It can also be registered to a beneficiary, who can only redeem the bond after the owner dies.

Types of Savings Bonds

There are two types of savings bonds currently available: I and E. Both range from a minimum of $25 to a maximum of $5,000. I bonds offer a fixed rate of return and a variable, semi-annual inflation rate, as do E bonds purchased after May 2005. E bonds purchased before May 2005 accrue interest based on calculations of the six month averages of treasury securities yields.

Benefits and Disadvantages

Savings bonds offer both benefits and disadvantages when held in a custodial account. They carry very little risk, but as with most low-risk investments, savings bonds offer modest returns. Bonds cannot be redeemed before one year and have an interest earning period of 30 years. If you redeem bonds before five years pass, you must forfeit the most recent three months of interest as a penalty. Interest earnings are subject to federal income tax unless they’re used toward education costs.

Custodial Accounts

Custodial accounts can be created at a bank, credit union, savings and loan, a mutual fund company or a brokerage firm. In the case of custodial accounts for minors, the custodian has control over the account until the minor reaches 18 or 21 years of age, based on state law. At that time, the custodian is responsible for closing the account, and all contents are transferred to the beneficiary. Retirement custodial accounts are generally limited to mutual funds or other products from regulated investment companies.

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