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Using UGMA/UTMA accounts
UGMA/UTMA accounts are custodial accounts you may use to save for your child's college education. Contributions to the account to pay for future higher education expenses are exempt from gift taxes as long as no more than $12,000 (in 2007) is contributed by a single donor to a single child.. .
(Note: The Economic Growth and Tax Relief Reconciliation Act of 2001 added a new tax rate of 10%. This new rate applies to the first $7,825 (in 2007) of income for single taxpayers.)
If the child is under 18, the first $850 (in 2007) in earnings on an UGMA/UTMA account is tax-free. The next $850 is taxed at the child's tax rate. At higher levels, earnings on the account are taxed at the parents' highest marginal income tax rate.
The following table shows the future value of monthly contributions to a tax-exempt account. (Keep in mind that the earnings -- not the contributions -- to an UGMA/UTMA account are taxable. After the child turns 18, the earnings are taxed at the child's tax rate.)
For example, if you contribute $250 monthly, invested at 6%, the future value in 18 years is $97,322:
Monthly
Amounts |
6.0% |
8.0% |
10.0% |
| $100 |
$38,928 |
$48,328 |
$60,556 |
| $250 |
$97,322 |
$120,821 |
$151,391 |
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Financial professionals may recommend that you buy growth stocks or mutual funds that invest in growth stocks for UGMA/UTMA accounts. Since growth stocks usually don't pay dividends, the account grows instead by earning capital gains. Capital gains earned over a period of more than one year are taxed at a lower rate than ordinary income. The tax rate on long-term capital gains is 5% for investors in the lowest tax brackets. For all other brackets, the tax rate is 15%.
There are two major drawbacks to using UGMA/UTMA accounts:
- Impact on applying for student financial aid. The expected-family contribution formula used to calculate a child's eligibility for financial aid assigns a greater weight to assets held in UGMA/UTMA accounts. This is because these accounts are considered the child's assets.
- Loss of control of assets. Since UGMA/UTMA accounts are considered the child's assets, the child gains control of them when they reach age 18 or 21, depending on the state.
(Note: This document is in Portable Document Format (PDF). If you do not have a PDF reader installed on your computer, you can download a version of Acrobat Reader for free at Adobe Systems' Web site.)
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.
Next, we'll take a look at the major types of student loans and rules for deducting interest on those loans.
Next Topic: Loans & interest deductions
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