Saving For Your Child's Education

The UGMA and UTMA Accounts

Q: How can the Uniform Gift to Minors Act help me save for my children's college?

A: The Uniform Gift To Minors and Uniform Transfer To Minors accounts are custodial accounts. Under a custodial account, the child is treated as the owner of the account, but the custodian (presumably the parent) controls the investments. The UGMA and UTMA accounts hold the assets in your child's name and Social Security number. Up to a point, any gains, income, or dividends on the account are taxed at the child's level.

UGMA and/ or UTMA accounts are available in all states.

Q: What are the tax benefits of the UGMA and UTMA?

A: An individual (not necessarily just a parent) can transfer up to $10,000 per year into one of these accounts without incurring federal gift taxes. Transfers to UGMA and UTMA accounts by grandparents can also lower overall estate and inheritance taxes. Funds in the accounts can be used by the custodial parents "for the good of the child" (the law sets limits) until the child reaches the age of majority as determined by individual states (18 or 21).

The accounts can also be used to reduce reduce a parents' overall taxes by transferring money that would, under any circumstances, be used for the child's benefit. For children under age 14, the first $700 of investment earnings are tax free. The next $700 are taxed at the child's rate (probably 15%). Anything earned over $1,400 is taxed at the parent's rate.

Once the child turns 14, all of the earnings are taxed at the child's rate.

Q: What are the Drawbacks of The UGMA and UTMA?

A: There are several drawbacks to the UGMA and UTMA accounts:

    Once money is transferred to the account, the donor can not take it back.

    It can only be used for lifetime gifts (not gifts made by a will).

    Only certain kinds of property are covered: money, securities, life insurance, or annuities. (NOTE: UTMA accounts may be invested in real estate, royalties, patents and paintings.)

    Once the child reaches a maximum age (set by each state), only the child can make withdrawals from a UGMA account. At that point, the money becomes hers and she can use it for whatever she wants (NOTE: UTMA accounts permit postponing distributions until age 18, 21 or 25, depending upon the state.)

    If you set up a UGMA, name yourself as the custodian, and you die before the funds are turned over to the child, the account will be taxed as part of your estate.

    Any withdrawals must benefit the child. Legitimate withdrawals generally include college expenditures, summer camp or other activities that solely benefit the child. Technically, if a custodian uses money in a way that doesn't benefit of the child, the child can sue for misappropriation of their UGMA.

    Colleges and financial scholarships generally require that 35% of a child's assets be used to pay tuition before calculating any award of financial need. This figure is approximately 6% for parents' assets. Depending on how much you end up with in a child's name, any tax savings realized by the parents could be significantly offset by the loss of financial aid given by the school.
    NOTE: UGMA and UTMA funds can be used for expenses such as summer camp, high school tuition, etc., before financial aid forms are filled out. Using the funds this way can take advantage of the tax benefits without impacting financial aid for college.

Educational IRAs

Educational IRAs are tax-deferred savings accounts established for a named beneficiary under the age of 18. You do not have to be related to the beneficiary to make a contribution on their behalf. The contribution itself is non-deductible (made with after - tax dollars) and any interest earned on the investment is tax-free if it is used for qualified expenses.

Any contributions made to an Education IRA must:

1. Be made on or before December 31st of the tax year;

2. Be made before the designated beneficiary reaches 18;

3. Total no more than $500 in aggregate contributions per year per beneficiary. Contributions in excess of $500 per beneficiary are subject to a 6% excise tax for each year the excess amount remains in the account.

Income Llimitations

Individuals filing singly, with an adjusted gross income of less than $95,000($150,000 for married couples) can contribute up to $500/year, per beneficiary.


Money withdrawn from Education IRAs can be used to pay for the "Qualified higher education expenses" of the beneficiary. These expenses are defined asas tuition at eligible post-secondary educational institutions, room and board, fees, books, supplies, and equipment required for enrollment or attendance. They also include graduate level course expenses.

Withdrawals from educational IRAs are tax-free provided that:

The qualified education expenses equal or exceed the total IRA distribution for that year.

A HOPE credit or Lifetime Learning credit wasn't claimed in that same tax year.

Any amount that is withdrawn in excess of qualified expenses is added to the beneficiary's ordinary income. There is also a 10% penalty on the withdrawal of the excess amount.

An Education IRA must be completely distributed within 30 days after the beneficiary of the account turns 30, or the remaining balance can be rolled over to another Education IRA to benefit another family member, without income tax or other tax penalties.

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