Uniform transfers to minors accounts allows someone to make a gift or a transfer of property to a minor without setting up a trust. All transfers to UTMA accounts are considered irrevocable and the donor cannot reclaim the gift or change the beneficiary of the account.
An adult is designated as the custodian to manage the account for the benefit of the minor until the child reaches the age specified in the statute. Custodians have certain powers and responsibilities under these laws and they should consult with legal counsel to understand their obligations with respect to the account. Once the child reaches the designated age (usually age 18, 21, or 25), the custodian is responsible for distributing the assets to the minor.
An attractive benefit of setting up a UTMA account is that there is no penalty if the child does not utilize the funds for education. If the child would rather use the funds to establish a business or cover medical expenses, he or she could do so without incurring a 10 percent penalty. Additionally, no income restrictions exist. An individual may contribute to a child’s UTMA account regardless of their personal income. There is no limit on the amount that can be contributed to these accounts, but in 2008, only $12,000 can be gifted without gift tax consequences. Lastly, all earnings are taxed to the minor. Annual earnings under the “kiddie tax” limit ($1,300 in 2008) are taxed at the minor’s appealing marginal rate. However, earnings over the “kiddie tax” limit will be taxed at the parent’s marginal rate.
Unfortunately, these benefits are not without costs. Once the child reaches the designated age, the funds become theirs to use however they like. There is nothing to prevent the child from purchasing a sports car rather than pay for college. Another major drawback of UTMA accounts is that they do not present any tax advantages. Finally, the account may be included in the child’s assets when determining financial aid eligibility.
ROTH IRA funds may be withdrawn without penalty for a small handful of reasons aside from retirement, and higher education fits within these requirements. Contributions to ROTH accounts are not deductable, but may be withdrawn tax-free if used for a qualified expense. ROTH accounts are a great option in that if the funds are not used for education, they can continue to grow tax-free until the individual reaches age 59.5 or retires and commits to taking substantially equal payments.
Unfortunately, contributions to a ROTH account can only be as much as the child’s earned income for the year. Consequently, this education funding method is not an option until the child is old enough to have a job that produces income, which will limit the time to attain tax-free growth before college.
Contributions to ROTH accounts are limited to $5,000 in 2008, and can be made up to the time of the child’s tax filing without extensions.