Dear dxw,
There are three main decisions that need to be made before you set up a college
account for your niece. They are:
1. Who do you want to have ownership of the account?
2. What kind of account will be best suited to your needs?
3. How do I set it up?
There are two categories of accounts that you can set up in someone else's name
depending on who has ownership of the account. These two categories are
clearly explained in an article on motelyfool.com entitled, "Investing for your
Kids: Who Owns It,"
http://www.fool.com/money/investingforkids/investingforkids02.htm .
With a guardian account, you own the fund and you are responsible for the
subsequent taxes, which are taxed according to your tax bracket. Guardian
accounts allow you to "informally earmark funds for your child in an account in
your name."
A custodian account would be better suited to your goal of enjoying tax
benefits while setting up this college fund for your niece. With a custodian
account, your niece would be the owner of the account. You control the account
as long as your niece is a child, but all activity on the account is taxed at
the child's rate, which is most probably lower than yours. The custodian
account has better tax benefits than the guardian account, however, it requires
forfeiting "long-term control . . . as well as ownership."
Before going on to the second question of "What kind of account will be best
suited to your needs?" there is one more important point about custodian
accounts. There are two types of custodian accounts: (1) the Uniform Gift to
Minors Act (UGMA), and (2) the Uniform Transfers to Minors Act (UTMA). As with
all custodian accounts, you control the money, but the account is in her name.
The UGMA allows you to give gifts to your kid while you are both still alive,
and you can give them "money, stocks, life insurance, or annuities." The UTMA
give you control over the account for a little longer period than the UGMA, and
the UTMA allows you to invest in a wider range of assets. As explained in the
same article quoted above, "You can postpone distributions to your child until
as late as age 25, depending on the state in which you live. [The UTMA] account
can be invested in real estate, royalties, patents, and paintings [and] the
UTMA account generally allows the property to be used or spent for broader
purposes than support obligations. " For more details on the difference
between UGMA and UTMA custodian accounts please read "Gifts to Children" by Roy
Lewis,
http://www.fool.com/school/taxes/taxes14.htm .
There are two options when you are deciding what kind of an account you will
open: IRA or non-IRA. These distinctions are clearly defined in the
articles, "Investing for your Kids: IRA Options"
http://www.fool.com/money/investingforkids/investingforkids03.htm
and "Investing for your Kids: non-IRA Options"
http://www.fool.com/money/investingforkids/investingforkids04.htm .
There are three IRA options: traditional IRA, Roth IRA, and Educational IRA.
The Roth IRA is not well suited your purpose of setting up a college fund for
your niece because there are penalties for withdrawing the money before she
retires. Similarly, for the traditional IRA if you withdraw money from the
account prior to retirement you will have to pay "income tax and a 10% penalty
on whatever earnings have accrued." The Education IRA (now called Coverdell
Education Savings Accounts) however, "under the Tax Relief Act of 2001, —
starting in 2002 you can now contribute $2,000 annually (compared to $500 in
2001)" and you can withdraw it for your niece's college education.
Smartmoney.com : College Planning
http://www.smartmoney.com/consumer/index.cfm?Story=200106083
The account will be in your name if you niece does not have an earned income
because only income earners can own an IRA. For more information on opening
IRA for your children please see the article, "IRAs for Kids,"
http://www.fool.com/taxes/2000/taxes000512.htm
If you choose an IRA account, and you want to use the earnings for your niece's
college education, the Education IRA is your best option.
Your non-IRA options are essentially guardian accounts, custodian accounts,
trusts and the 529 Plan. As described before a guardian account is essentially
the same as your account – your name is on the account, it is your money and it
is taxed at your rate. The custodian account has the child's name on it, but
is controlled by you until the child is 18 or 21 years old, depending on the
state in which you live. The tax advantages are that the "first $650 is not
taxable, and any amount over $650 will be taxed at your child's rate. Period.
There will be NO tax at your (the parent's) rate -- no matter how much your
child earns. This is one of the things that makes the UTMA/UGMA accounts so
appealing."
"Investing for Kids: non-IRA Options"
http://www.fool.com/money/investingforkids/investingforkids04.htm
Trusts are more appropriate for persons with "certain
situations . . . .concerned about estate taxes." Trusts are complex and
usually require the assistance of a professional. For more on trusts please
see "Investing in Your Kids: Who Owns It,"
http://www.fool.com/money/investingforkids/investingforkids02.htm .
Lastly, the 529B account that you mentioned is also another viable option for
you. The 529 plan allows you to contribute significantly more to the account
annually. In the article, "The 529 Basics" on Smartmoney.com it says, " Many of
the state plans let you contribute more than $100,000 and some (like
Wisconsin's Tomorrow's Scholar Fund) allow a maximum contribution of $250,000
that can then grow tax-free." Additionally, it is easier to "roll-over" your
account from one to another. " Under the old rules, account rollovers were
only permitted if you changed beneficiaries. The new rules also make 529 plans
more attractive to grandparents, since they can now transfer an account between
cousins if, say, the original beneficiary decides not to go to college."
Secondly, you can contribute a larger amount of the 529 fund to expenses should
your niece live off campus.
The negatives of the 529 plan are:
1. " while future withdrawals will be tax free, you might owe gift tax if
you contribute more than $11,000 annually"
2. " unlike an UGMA or UTMA (which are essentially custodial accounts set
up for minors), 529 plans are not irrevocable gifts"
For a more detailed description of the 529 and choosing the right plan please
read, "The 529 Basics" by Stephanie AuWerter,
http://www.smartmoney.com/consumer/index.cfm?Story=200106083
To set up an account for your niece you can go to a bank, a mutual fund
company, or a broker depending on which type of account you choose. As
discussed in "Investing in Your Kids: How Do I Set up an Account,"
http://www.fool.com/money/investingforkids/investingforkids06.htm
it is important that you are well informed on all of your investment options
before you begin calling to set up an account. Know what you are looking for
and then start calling.
In summary, based on your goals of setting up a college fund for you niece and
wanting to enjoy tax benefits along the way, you best options are either an
Education IRA or the 529B plan, depending essentially on how much you are
planning on contributing yearly.
For more help on comparing your investment options please see the comparison
charts at,
Motleyfool.com : Some Sample Comparisons
http://www.fool.com/money/investingforkids/investingforkids07.htm ,
and Motleyfool.com : Accounts Compared
http://www.fool.com/money/investingforkids/investingforkidsaccount.htm
Additional Websites that may interest you:
Internal Revenue Service Website
http://www.irs.gov/
Internal Revenue Service : Tax Professionals
http://www.irs.gov/taxpros/display/0,,i1%3D5%26genericId%3D23088,00.html
Smartmoney.com : College Savings Without the Tax Bite
http://www.smartmoney.com/college/investing/index.cfm?story=paytoday
Motleyfool.com : Paying for college
http://www.fool.com/money/payingforcollege/payingforcollegestep3.htm
Motleyfool.com : 60-second guide to choosing a broker
http://www.fool.com/60second/broker.htm?ref=60ira
Motleyfool.com : "The Kiddie Tax"
http://www.fool.com/taxes/2000/taxes000324.htm
Search Terms Used:
IRS
IRA
College savings accounts
I hope that this information is helpful. Good Luck!
Cheers,
shal |
