Through a Uniform Transfer to Minors Act (UTMA) trust account, typically called a custodial account, parents, grandparents, or simply generous folks (if you’re that lucky) are able to gift assets such as money, real estate, stocks, bonds, patents and royalties, and more to a minor.
There are several reasons parents might want to have a custodial account for their child. Maybe you want to build wealth for your child while maintaining control of the assets in the account until he/she reaches majority age. Or you may be looking for a reduction in tax liability (always consult with a tax advisor for your specific situation).
And some parents may plan to use the assets in this type of account for their child’s college expenses. But take heed…
While a custodial account may be a tax-efficient way to save for college and might involve lower fees and/or more options than a 529 plan, you’ll need to especially keep an eye on “kiddie tax” implications and financial-aid eligibility.
Here’s How an UTMA Works
Parents, grandparents, or those generous folks can each gift up to $14,000 per year (the most you can give without filing gift tax forms). The gains each year from the UTMA are reported under the child’s social security number. A dependent child can earn up to $1000 (in 2014) in interest income without having to file a tax return, and the next $1,000 is taxed at the lowest income tax bracket. So caveat #1: Any income above $2,000 is then taxed at the parent’s bracket under the Kiddie Tax.
Then caveat #2: If the custodial account grows too large, the assets are treated as belonging to the minor student and therefore count heavily against eligibility for financial aid. This is because student-owned assets including UTMA accounts are assessed at a 20% rate in determining Expected Family Contribution (EFC). The interest earnings also contribute to student income, which above a certain allowance is also subject to a 50% assessment rate in determining EFC.
On the other hand, parent-owned assets are subject to a much-lower 5.64% assessment rate in the EFC formula. So, parents of children with existing UTMA accounts could consider transferring the funds into a 529 plan before filing the FAFSA (Free Application for Federal Student Aid) to convert a 20%-counted asset to a 5.64%-counted asset, since a special provision in the financial-aid law treats a 529 plan owned by either the parent or the student as a parent asset, not a student asset. The 529 account also has the advantage of throwing off tax-free income when used for college, which doesn’t have to be added back on the income portion of the FAFSA (again, consult with your tax advisor for details specific to your situation as any taxable gains triggered by a transfer will need to be considered for a potential impact on income tax and financial aid forms).
So What’s the Bottom Line?
You should feel free to consider using UTMA custodial accounts for your student’s college savings, but generally only to the extent they won’t trigger the kiddie tax in any future years. For families capable of saving more substantial amounts for college, a strategy that includes both UTMAs and 529s might be the better option.
Want to talk through education-planning options related to your specific situation? Give us a call!
800.522.6009/request to speak to a Vantage Investment Services Group representative