Consider Custodial Accounts for Your Kids
“I wish Larry Jr. had a better understanding and appreciation for money,” said Dad. “I’d like to find a way to make him feel that he’s a part of our family finances, without just handing over money every time he asks.”
This smart dad is thinking of setting up a custodial account for Larry Jr. that will help his son gain some financial planning know-how. With the account, by the time Larry Jr. turns 18, he will have access to—and hopefully a good plan for—this financial gift. This is just one of the advantages of custodial accounts. These accounts are simple and flexible, and anyone can open one, no matter their income level.
Custodial accounts have been around for years and are used to hold and protect assets until a child reaches the age of 18 (or older in some states). Although there are other options to help the kids financially, such as starting a 529 account for college, opening a 401(k) on their behalf or setting up formal trusts, a custodial account works best in some circumstances. You should investigate all gifting options available to find the one right for you and your child.
These custodial accounts, known as UGMAs (Uniform Gifts to Minors) and UTMAs (Uniform Transfers to Minors), allow the donor to gift all types of securities, such as bank deposits, real estate and stocks. UGMA accounts are a bit more restrictive.
Another advantage is the tax savings, aka the “kiddie tax.” Be sure to fully understand the restrictions. The first $1,000 of unearned income is tax exempt from the minor child. The second $1,000 of unearned income is taxable at the child’s tax rate, and you may need to file a tax return for your youngster. Any amounts over $2,000 are taxable at either the child’s or the adult’s tax rate, whichever is higher. State income taxes may also be due. The annual federal gift tax exclusion is currently $14,000 per year ($28,000 for married couples). An UGMA or UTMA does not affect the $1 million federal gift tax exemption.
The money is irrevocable, which means the custodian or a donor cannot withdraw any of the funds. However, under some circumstances, the money may be used for the benefit of the custodial child before he or she reaches “adulthood.” However, basics such as food, clothing, shelter and even general medical care are disallowed.
A word to the wise: the day the child turns a legal adult, usually 18 but the age might be older depending on the state of residence, he or she will have full access to the account funds. No restrictions are placed on these funds. If the recipient wants to spend the money unwisely—even if the custodian had something else in mind—he or she is free to do so. Other accounts, such as a 529 or Coverdell Education Savings Program can only be used to pay for education expenses.
Another caution: if the recipient of the account, once he or she is of age, wants to receive financial aid for college, that money becomes an “asset.” These assets are considered as part of the student’s total finances and could affect eligibility. If you feel this may be an issue, speak to your tax or financial professional about alternatives ahead of time. In this case, it could be that a 529 account is a better option.
Becoming a custodian of an account such as an UTMA and UGMA comes with restrictions and responsibilities other than those cited here. Be sure to talk to your financial professional.
This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax situation is different. You should contact your tax professional to discuss your personal situation.
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Provided by courtesy of Herb White, MBA, CFP®, a CERTIFIED FINANCIAL PLANNER™ with Life Certain Wealth Strategies, 8400 E Prentice Ave, #715 Greenwood Village, Colorado, www.lifecertain.com, (303) 793-3999. Securities and investment advisory services offered through Woodbury Financial Services, Inc. Member FINRA, SIPC and Registered Investment Advisor. Life Certain Wealth Strategies and Woodbury Financial Services are not affiliated entities. Neither Woodbury Financial Services, Inc., nor its registered representatives or employees, provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.