FastFacts: Putting Money In Your Child’s Name

The basics: As a tax-saving strategy, some parents shift assets into custodial accounts for their children under the Uniform Gifts to Minors (UGMA) or Uniform Transfers to Minors Act (UTMA). Before you do so, weigh the pros and cons carefully and consult your tax advisor.

Taxes: Since the creation of the so-called "kiddie tax" in 1986, the tax advantages of making this move for children under age 14 aren’t as great as they once were.

Specifically, under 1998 tax law for children under age 14, the first $650 of unearned income is free of federal tax. The next $700 is taxed at the child’s rate, typically the 15% minimum. Any additional unearned income above this $1400 is taxable to the child, but at the parents’ top marginal rate. For children over age 14, the first $700 of unearned income is free of federal tax.

Gifts are irrevocable: Assets you put into custodial accounts are irrevocable gifts. As custodian, you may only spend this money for purposes that benefit your child, excluding usual parental obligations such as food and clothing. Once your child reaches the age at which custodianships end under UGMA or UTMA, generally 18 or 21 depending on your state law, the money generally goes to your child, who is free to do whatever he or she pleases to do with it. One plus: In states where custodial accounts end at age 21, parents may have already used most of the money in their child’s custodial account by that time for college bills.

Financial aid considerations: Putting money in your child’s name may limit your family’s eligibility for needs-based financial aid. (Some financial aid is non-needs based, such as Federal Unsubsidized Stafford student loans and PLUS loans.) That’s because students are expected to contribute 35% of their assets towards college expenses each year,while parents are only expected to contribute 5.6%.

If you already have money in your child’s name, and you’re concerned about the financial aid consequences, you may be able to spend down the account for such things as a computer, summer camp, music lessons, or other extras. Before you do so however, check with your tax advisor since the laws vary from state to state.

Gift tax considerations: Currently, you can give up to $10,000 a year to someone in cash, securities, or other property without owing any gift tax. A married couple can give a total of $20,000 free of gift tax to any number of people. Starting in 1998, these amounts will be indexed for inflation.