Question: Our daughter is 4 and we’re starting to save for her college fund. Should we set up accounts in her name or our names?
Answer: This really depends on your situation, so I caution you to talk with an attorney, tax professional or financial advisor.
Typically, though, I find there are a few points you should consider before setting up accounts in your child’s name: financial aid issues, the kiddie tax, and the loss of parental control.
Financial Aid: The federal financial aid rules have a more negative impact on a child assets than parental assets. The more assets a child has, the more he or she will be expected to contribute to college costs, and the less financial aid he or she will receive, because the financial need is less. Under the current federal aid formula, a child is expected to contribute 20 percent of his or her assets to college costs each year, whereas parents are expected to contribute 5.6 percent of their assets each year. So $10,000 in your child’s bank account would equal an expected $2,000 contribution from your child, but that same $10,000 in your bank account would equal a $560 contribution from you.
Keep in mind, though, that the average financial aid package consists mostly of loans, not grants and scholarships. So the financial aid impact may not be significant depending on your personal situation.
Kiddie Tax: At one time, saving money in a child’s name was recommended because of the tax saving opportunities in children being taxed at their own (usually lower) rate. However, Congress partially closed this loophole some years ago with passage of special rules commonly referred to as the “kiddie tax.” The kiddie tax makes your child’s unearned investment income over a given amount subject to tax at the parents’ tax rate. Currently, the limit is $1,900 (the first $950 is tax free and the next $950 is taxed at the child’s rate). The current kiddie tax rules limit the tax savings potential of a child holding assets in his or her name.
The kiddie tax rules apply to: (1) those under age 18, (2) those age 18 whose earned income doesn’t exceed one-half of their support, and (3) those ages 19 to 23 who are full-time students and whose earned income doesn’t exceed one-half of their support.
Loss of Parental Control: Finally, and to me the greatest issue, is that of a loss of control over the assets. Many parents open a custodial account for their child (UGMA or UTMA) to save for college. However, when the child reaches the age of majority (18 or 21, depending on the state), he or she gets full control over the money in the account and can use the money for anything–college, travel, a sports car, etc.
What could possibly go wrong with that scenario??? I think you get my point. Some parents aren’t aware of this when they set up these accounts and most of the parents I talk with don’t like the idea of relinquishing control to their child.
Based on these factors, I usually recommend that parents save for college in their own names, but situations vary. So, talk with your advisor or attorney before making a final decision.
Related articles
- How to Keep a Non-Custodial Parent out of the Financial Aid Process Legally? (ask.metafilter.com)
- The College Savings Cheat Sheet (education.com)