Childrens Accounts for Saving and Investing

Last Updated Jan 11, 2011 2:41 PM EST

I often get questions from readers and sometimes I'll answer them here. If you have questions you'd like to ask, please email me by clicking on the "Contact Ray Martin" link to the left.

Question:
Hello Ray, Could you please comment on the Uniform Gift to Minors accounts? Would this a good idea for children/grandchildren savings, not necessarily for education funding, but for passing on monies to children/grandchildren? Thank you, Joyce

Ray Answers:
I often get questions from folks who want to fund financial accounts, which their children can later use towards the down payment on their first home or to give them a head start on their retirement. The basic issue with investment accounts for children is that generally, individuals under the age of 18 are not permitted to directly own these accounts. However, there are several types of accounts that I suggest for people to open to use for investing funds for children.

UTMA/UGMA Accounts - If you want to buy and sell securities in a brokerage account for the benefit of a minor, then consider a Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) account. The version you will use depends on the laws of your state. Under this type of account registration, the adult (typically a parent) is the custodian and the child is the beneficial owner. When the child reaches age 18 (or 21, depending on your states laws pertaining these accounts), then the account should be converted into sole ownership in the child's name. Investment income from these accounts is taxed in 2011 as follows. Assuming the child has no other income and is under age 19 (or 24 if a full-time student), the first $950 of unearned income is sheltered by the child's zero bracket. The next $950 is taxed at 5% or 10%, and the rest is taxed at the parents' top marginal tax rate. The tax on a child's income imposed at the parents' top bracket is the so-called "kiddie tax." If the child is 19 and not a student, or 24 regardless of student status, then all the income is reported on the child's own tax return. There are a few drawbacks to UTMA and UGMA accounts so be sure to know about these before you jump in.

Roth IRA - Children can open and contribute to a Roth IRA as long as they have wage income regardless of their age. Contributions can be invested in stocks or mutual funds and distributions after retirement are tax-free. These also allow for tax-free withdrawals of contributions and penalty free withdrawals of earnings when taking money out for the first-time purchase of a home. Up to $5,000 in annual contributions to a Roth IRA is allowed. If your kids have any taxable earnings in 2011 and you want to give them a head start on the future purchase of a home or their retirement savings, then help out by opening and making a contribution to their Roth IRA.

Grantor Trust - Individuals who want to give their children or grandchildren larger financial gifts but want to maintain some control as to how the money is managed and when the children receive it should consider a simple Grantor Trust. Under these trusts, parents specify a trustee and how the money contributed is to be used for the child's education, care, etc. The person setting up the trust can contribute up to $13,000 in 2011 into a trust for each child named as the beneficiary. This most common use for this type of trust is for estate tax planning purposes. The downside is the expense and time required to draft a Grantor Trust document and preparation of an annual tax return from the trust. But if you intend to accumulate a large amount of assets in this trust, then having the control and discipline of a trust structure can be worth it.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.