Personal Finance

Money Matters: Tax changes make custodial savings accounts less attractive

Q. Several years ago, I began contributing to a Uniform Transfers to Minors Act account in a no-load mutual fund in my daughter’s name with myself as custodian. It has done well and is now worth around $25,000. In the fall of 2017 she will begin college. Should I continue to contribute to this account or keep contributing to her 529 plan? I already have over $75,000 in a 529 plan and I figured the UTMA money could help with expenses in college that the 529 plans don’t cover. I know my parents have a 529 for her as well but I’m not sure of the value. Is there any special planning we can do for college financial aid purposes?

A. You may want to speak with a tax professional that has some expertise in financial aid, but I can provide some guidance that may be helpful.

Tax changes have made custodial accounts such as the Uniform Transfers to Minors Act accounts very unattractive. Custodian accounts no longer allow unearned income of children age 14 or over to be taxed at the typically lower children’s tax rate. Under current tax law, unearned/investment income of more than $2,000 of children under age 18 will be taxed at the parent’s rate.

Once a son or daughter turns 18, the investment income will be taxed at the child’s rate, but full-time students age 23 and younger will have to pay taxes owed from these accounts at their parent’s tax rate. Students age 19 to 23 will be exempt from this requirement if they are earning income totaling more than half of their support, or file a joint return with a spouse. A child’s investment income will first be reduced by a $1,000 standard deduction; the next $1,000 will be taxed at the child’s rate and the remainder at the parent’s rate. This “kiddie-tax” may be taxed at a higher rate than the parent’s because the tax is computed by adding the child’s investment to the income of the parents, which may place it in a higher tax bracket. The kiddie-tax may even be subject to the Alternative Minimum Tax.

Anything in a custodian account such as a UTMA will be counted as the student’s asset for purposes of financial aid.

Currently, money in a 529 college savings plan is counted as an asset of the parent for purposes of financial aid. Most aid formulas will assess student assets at 20 to 25 percent a year while reportable assets owned by the parents are assessed at 5 to 5.64 percent a year (home equity, retirement accounts, value of a small business and some other assets are not reportable for aid purposes).

For financial aid purposes, up to 25 percent of the money in a UTMA would be expected to be contributed toward college costs. Only 5 to 5.64 percent of the money in a 529 plan would be expected to be contributed toward college costs.

Money in a 529 plan owned by a grandparent is typically not reportable for aid purposes, but it is counted at colleges using the Profile aid method. Distributions from a 529 plan owned by a grandparent will impact financial aid eligibility.

If your daughter is planning to apply for college financial aid, you may want to consider using the money in the UTMA so it is nonexistent or has a very low value by the time she applies for college. The money must be used for the benefit of the beneficiary, your daughter. Fund her costs of summer camp, computer, phone, auto-related expenses etc. with the UTMA money rather than from your own account. If she has earned income, the money could be used to fund a Roth IRA, which is a non-reportable asset for aid purposes.

Editors note: Due to an editing error, a sentence in last week’s column about IRAs omitted a key word. The sentence should have said that you have until Dec. 31 of the year following the original IRA owner’s death to take your first Required Minimum Distribution.

Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624

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