3 Things You Should Know About… GIVING THE GIFT OF EDUCATION (part 3)

 

Taking the Fear out of Finance with Laura Redfern, CFP®:
3 Things You Should Know About… GIVING THE GIFT OF EDUCATION

1College savings strategies can be complex, and should be customized to your particular situation.  I hear a lot of questions about making educational gifts at this time of year, so I’ve split my “3 Things You Should Know About…” blog into 3 parts to address the 3 Most Common Savings GiftsMy 2 earlier articles addressed government savings bonds and 529 plans.  Today, Part 3 (The Final Frontier) will explore UGMA accounts, and I’ll conclude with the Top 3 Questions you should ask when considering this type of financial gift. 

UGMA/UTMA PLANS:
UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfer to Minors Act) basically establish a way for a minor to own property, such as money, without needing to hire an attorney to set up a trust.  The UGMA is the oldest of the college savings accounts options; the UTMA is the newer version.  These types of accounts were being used to help fund children’s education long before other options like 529’s came along.

Biggest benefit: flexibility in how money is spent
Because these are custodial accounts, the only restriction is that the assets must be used for the benefit of the minor.  That leaves a lot of room for flexibility: funds may be used for anything from education (such as private school, tutoring, or dance lessons), to buying a vehicle or a house.  Also, there is no age restriction on when the funds can be used, so you don’t have to wait until Junior is college-bound to access the money. 

Biggest complaint: owner doesn’t control the asset after the child reaches age of majority (age 18-21)
Money in an UGMA/UTMA is an irrevocable gift to minor, and this is an 2
important distinction.  Unlike a 529, this type of account does not allow you to change the beneficiary.  Ever.  Once you’ve made the gift, you’re done.  The Custodian of the UGMA (usually the parent or grandparent) has control over how the money is managed, but only until the child becomes and “adult” (as defined by the state; usually age 18 or 21).  At that time, the account legally becomes the child’s account, and potentially they can do whatever they want with it.  That’s when flexibility can be a double-edged sword: technically, Junior could clean out the account and purchase a motorcycle, whether mom and dad like that or not.

Other Interesting Info:
-The Donor (person contributing the money) does not have to be the same as the Custodian (adult in charge of how the account is managed, until minor reaches adulthood).  Grandma could contribute money to an account managed by Dad.
MEDIUM to HIGH impact on Financial Aid eligibility, because it is considered the Child’s Asset.  Be aware of this if you’re looking for needs-based financial aid.  According to current rules, an UGMA/UTMA will be factored into the Expected Family Contribution at a rate of about 35% (remember a 529 is considered a parental asset and included at only 5.6%).
Unique “kiddie tax” advantage:  Earnings and gains in an UGMA/UTMA are taxed annually, so you’ll have tax forms to file each year.  However, since this is the child’s asset, they are usually taxed to the minor, not the parent.  This can be an advantage because the child is allowed a certain amount of tax-free income each year.  After that, earnings and gains are taxed at the child’s rate (usually a low rate) – up to a threshold.  After that threshold, they are taxed at the parents’ rate.  Tax laws change often, so check with your tax advisor about whether this could be an advantage for you.

3The smart choice is:
There are other college savings strategies (such as using a Roth IRA for educational expenses, or the Coverdell ESA) which are not covered here.  The main point, though, is that there are plenty of ways to help the next generation have a brighter financial future.  If that’s an important goal to you, you should carefully consider the options out there.  Doing your homework and/or consulting with a financial professional who can help you choose the right tool for the job can be very rewarding, both for the giver and the receiver.

TOP 3 QUESTIONS YOU SHOULD ASK YOURSELF:
As with any investment, you should start by asking yourself what your goals and expectations are for this pool of money. 

  • What am I trying to accomplish in giving this gift? – Is it to encourage a child to attend college?  Is it to provide a child with general financial assistance?  Is it to watch money grow?
  • How soon will the money be needed? – A 2-year timeframe is very different from a 12-year timeframe when considering investments.
  • How much money are we talking about here? – What will be reasonably needed to achieve my goal? How much can I reasonably contribute and on what basis (monthly, annually, a one-time gift)?

TOP 3 QUESTIONS YOU SHOULD ASK YOUR ADVISOR:
If you are working with someone to help you sort through your 4
options, great!  After you’ve defined what’s most important to you, make sure you consider these aspects when making a final decision:

  • What are the rules regarding how the gift is redeemed/money is spent? 
  • What are the costs/fees associated with this account?
  • What is the potential impact on Financial Aid?

 

HELPFUL LINKS FOR MORE INFO:

www.savingforcollege.com/compare_savings_options

http://www.collegesavings.org/planComparison.aspx

http://www.finra.org/Investors/SmartInvesting/SmartSavingforCollege/P124117