As a holistic financial advisor, it’s always important that I view the big picture for my clients, and a very important piece of that picture is the children of my clients. We all want the best for our children and want them to have a life better than the one we had at their age. Sometimes our well-meaning actions will not always end up as intended.
Grandparents often gift money or assets to their grandchildren with the intention for those assets to be used for college, or parents simply set aside money for the proud day when their children go off to college. Most often these gifts end up in the child’s name in the form of a custodial account with a parent acting as the custodian of the assets. There are two types of custodial accounts: Uniform Transfer to Minors Act (UTMA) and Uniform Gift to Minors Act (UGMA). The state in which you live will require the use of one or the other. Essentially, they are identical and operate just like a bank or brokerage account (they are taxable), but the tax liability is the child’s.
Why I don’t like UTMA and UGMA accounts!
These accounts have several issues that keep me from recommending them. Here are a few reasons why I don’t like these custodial accounts.
- The money becomes the child’s at the age of majority. The child has the right to use the money in any way they see fit, and the parents are in no position to do otherwise. While we all intend to raise our children to be respectful of our wishes and do the right thing, it’s best not to give an 18 year old power over a substantial sum of money.
- You can borrow for college, but you can’t borrow for retirement. This is an important point. Again, we want the best for our children. But, we shouldn’t sacrifice our retirement so our children can go to college without paying a dime. Sending a child to college with some skin in the game (the child partially paying) will set a great example of what lies ahead in life. A student loan is much better than becoming a financial burden to your children later in life!
- Money in the child’s name can hurt in the financial aid process. UTMA and UGMAs are considered the child’s asset when it comes to the financial aid process for college, and assets in the child’s name hurt the financial aid process much more than assets in the parent’s name.
- Sometimes there are gift issues involved in custodial accounts. Many times these accounts are started as a gift from a relative (i.e. stock from grandparents). The cost basis of the person giving the gift is transferred to the person receiving the gift. This must be tracked and handled appropriately. It’s not difficult, but it does need to be done correctly.
- Another gift issue is gift tax. The federal gift tax exclusion is $13,000 a year, so any gift from one person to another in an amount over $13,000 would incur a gift tax liability. Even some states have stricter gift tax limitations (i.e. TN), so gifts should only be made with the full understanding of the applicable state and federal gift tax laws.
With the cost of college climbing, many parents are working hard to ensure their children’s future involves a college education, so it’s more important than ever not to make mistakes along the way. A custodial account may have unintended consequences, especially if set up incorrectly. Money is money, and money in the children’s name is still an asset that needs to be viewed as part of the big picture.
If you are looking for ways to save for college, all while keeping your financial plan intact, ACA is a great place to find an advisor who will keep the big picture in mind!