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Planning for College with a Custodial Account

Using a Uniform Gifts to Minors Act (UGMA) or Uniform Transfer to Minor Act (UTMA) account is an easy and legal way to transfer the ownership of assets to a child.  With a UGMA or UTMA account, the parent creates a custodial account on behalf of the minor child. Assets are transferred into the account and the custodian, usually a parent, manages the account until the child reaches legal age. At that point, the child can do whatever he or she wishes with the assets.

Transfers to these accounts are irrevocable. You cannot change your mind later and take the assets back. Your child becomes the owner when you make the transfer and on reaching the age of majority (18 or 21 in most states) the child can do whatever they wish with the money.

Transfers into a custodial account are just like any other gift.  For 2012, you can make annual gifts up to $13,000 in cash, securities or other property to anyone without owing any federal gift tax and without filing a gift tax return. 

If you are married, gifts can be considered to be half from you and half from your spouse.  This enables transfers up to $26,000 to be made.  However, a simple gift tax return may be required if you use this gift-splitting technique.  The annual $13,000 exclusion applies to each person receiving the gift.

When the assets become the child's, any income the assets produce is taxed to the child.  There are special tax rules that apply to children under the age of 18, 18 year olds with earned income less than half of their support, and 19 to 23 year old students with earned income less than half of their support.  These rules are commonly called the “Kiddie” tax.

The tax laws provide that the first $950 in 2012 of investment income from assets held in the child's name is tax free. The next $950 is taxed at the child's tax rate (usually the lowest rate of 10%). Investment income greater than $1900 in 2012 is taxed at the parent's rate until the child is no longer subject to the Kiddie tax.

The Kiddie tax rules were changed in 2007 and you may want to consult a tax advisor to determine how the rules may apply in your situation.