Accounts That Prove That "Custodial" Is Not Synonymous With Janitor
529 plans are generally the favored college savings vehicles, but there are a few options out there that come with more tax benefits than checking and savings accounts, better financial aid rates, and will not penalize you for using the savings for purposes other than educational ones. For students who are not sure if they want to go to college and families who want to keep their finances more accessible, here are some options:
Better known as "custodial" accounts, UGMAs (short for Uniform Gift to Minors Act) and UTMAs (short for Uniform Transfer to Minors Act) are savings or investment accounts controlled by parents designed to benefit children. You know those movies where wealthy, well-dressed teens are financially supported by trust funds they cannot access until they become legal adults? UGMAs and UTMAs basically work like that.
The cool part of UGMA and UTMA accounts is that there is no limit to the amount of funds that can be invested, account holders under age 18 will not pay a penny of federal income tax on the first $950 the account earns each year, and funds can be used for any purpose as long as they benefit the beneficiary (try saying that five times fast). Once the student reaches the age of majority - which ranges from 18 to 21 depending on the state - they can use UGMA/UTMA funds to head to college, enter a trade school, take an awesome vacation, do a volunteer project abroad, or roll it over to a 529 plan until they are ready to go back to school. Of course, they can also spend it on a fancy-pants car and clothes that would make Kim Kardashian jealous. Parents—know thy child and enter UGMA/UTMA accounts with caution.
If UGMAs and UTMAs sound too good to be true, that is because they are...kind of. These plans come with some pretty tight drawbacks including:
Students under age 18 who have substantial UGMA/UTMA accounts can get hit with some high fees. While minors can earn up to $950 per year tax-free on their accounts, those earning more will pay taxes. Get ready because we are about to get really technical. Students earning $951-$1,900 will be taxed at the student's tax rate while any earnings above $1,900 will be taxed at either the parent or the student's rate, whichever is higher. That may sound like gobbly-gook now, but it can translate to some unexpectedly high bills when tax season rolls around. Before opening an UGMA or UTMA, consult a tax advisor or you will fork over money to The Man.
UGMA and UTMA accounts basically do this to your future financial aid package if they are not rolled over into a 529 plan no later than the year before you apply to college. Like checking and savings accounts, UGMAs and UTMAs can cost students 20 cents in financial aid for every dollar stored in those accounts. If students move custodial funds into a 529, the blow will be reduced to 6 cents for every dollar they have saved for school.
Deciding whether an UGMA or UTMA is better for your family than a 529 or other savings vehicle boils down to the choice between having the freedom to use funds for whatever costs might come along versus getting better tax and financial aid breaks further down the road.
College Savings Cheat Sheet: UGMA/UTMA Accounts
Accessibility: High. You can use UGMA/UTMA funds to attend college, buy your books, or fulfill your dream of having a swimming pool filled with pudding. As Captain Planet would say, "The choice is yours." :)
Risk Level: It depends on what your account is. If your UGMA/UTMA is a savings account or is made up of conservative investment options, your risk is low. If it is made of aggressive options, the risk is high. :
Rate of Return: Depends on what's in your account and how the market performs :
Tax Benefits: Moderate. Some federal tax incentives are available; no state tax benefits. :
Impact On Your Financial Aid: High, unless rolled in to a 529 plan. :(