Establishing a custodial account can provide a simple way to set aside money for higher-education expenses. All 50 states have adopted the Universal Transfers to Minors Act (UTMA)¹, or its predecessor, the Uniform Gifts to Minors Act (UGMA). The basic principles of both acts are the same.

With a custodial account, you (or someone you name) act as custodian of the investment until the child attains the specified age under the Act, (age 18 or 21 in most states). Any individual can transfer funds to a minor in a UTMA/UGMA account, and there is no limit on the amount that may be gifted to a child. The custodian retains all management obligations and may only use the funds for the minor child's benefit.

Once funds have been given as a gift to a child, the child legally owns the funds and the income from the funds over time. (Depending on the child's age, his or her income may be subject to the "kiddie tax" rules.²

FOOTNOTES

¹According to a recent status report, UTMA is pending in Michigan and has not been adopted in South Carolina or Vermont. All other states and the District of Columbia have adopted UTMA.

²If your child is under 14, the first $850 of unearned income (income not representing compensation for services) is tax free because of the child's standard deduction. The second $850 of unearned income is taxed at the child's marginal income tax rate. Any unearned income over $1,700 is taxed at the higher of the parent's maximum marginal income tax rate or the child's tax rate. The parent's rate applies even if the gift comes from someone else.