You can lower your own tax liability and raise funds for your kid's future through the Uniform Transfer to Minors Act. Every state except Vermont and South Carolina enforces the UTMA, although the precise wording of the act varies between states. Like many other investments, some withdrawals could lead to you paying both fees and taxes.
The UTMA wasn't designed as a college savings account, but that's how many people use it. You establish one in the name of a child and transfer some of your assets into the account. Earnings on the account are taxable to the owner. That's one reason many adults like these accounts since that owner is a child, and children are typically in a lower tax bracket than adults. As of 2012, you could give the account $13,000 as an individual or $26,000 as a couple without having to pay a gift tax.
Every UTMA account has a designated custodian who can make withdrawals or cash in the account at any time. However, the cash can't be used for day-to-day expenses like groceries. It can be used for school outings, music lessons and other non-essentials that benefit the child. When the account owner reaches legal adulthood -- which is 18 in most states -- the custodian's role comes to an end. At that point, the actual owner can use the cash for college, to buy a car, or anything else she wants.
You can invest UTMA funds in savings accounts and even mutual funds. Although income tax is assessed on the account earnings on an annual basis, the owner may also have to pay capital gains taxes after cashing in the account. This can happen if the investments in the account, such as mutual fund shares, grow in value. Gains realized within a year are considered short-term gains. They're taxed at the same rate as ordinary income tax. Longer term gains are taxed at the federal capital gains rate. Those taxes are paid by the owner of the account.
When you cash in mutual fund shares, you sometimes have to pay a back end load commission. It's deducted from the account. You may also have to pay administrative fees when you close the account. Likewise, banks often impose interest penalties if you cash in a certificate of deposit inside a UTMA before it reaches maturity. None of these fees are exclusive to UTMA accounts.
- How to Open a Custodial CD Account for a Minor
- The Difference Between a SEP IRA & a Simple IRA
- What Is the Difference Between a Roth IRA & a Non-Qualified Account?
- What Is the Difference Between a Trust Account & an Escrow Account?
- How to Convert a Roth IRA to a Traditional IRA and the Taxes
- Can an IRA Be Opened Without a Custodian?