Kids Accounts
Let's get ready to rum-blllle!
by Phil Weiss
([email protected])
TOWACO, NJ (Aug. 6, 1998) -- Last night we talked about whether or not investing in Cash-Kings is appropriate for accounts earmarked for college savings. Tonight we're going to continue the discussion by going over some of the ways to set up such accounts.
Believe it or not, it was a lot easier to decide that we wanted to invest money that we were putting aside for our son's education in Cash-King stocks than it was to decide what type of account the money should be deposited into. It really is incredible to me how many different options there are.
Among the account choices that I found in my research or knew of from my professional experience are custodial accounts, which include Uniform Gift to Minors Accounts (UGMA) and Uniform Transfer to Minors Accounts (UTMA) depending on where you live; various kinds of trusts; Education IRAs; accounts in the child's name; and accounts in the parent's name with the intention of using it for the child's education at a later time. Whew. The only way to get through this report is to bring in a ring announcer to fire us up, so...
"Let's get ready to rum-bllllllllllllllle!"
First I'd like to briefly describe each of the account choices.
Custodial accounts are essentially nothing more than a simple way for minors to own securities. In most states, those under age 18 don't have the right to enter into a legal contract. So, a minor cannot be bound by a broker's agreement. If a broker took a minor's account, the minor, upon reaching adulthood, could repudiate any losing trades and make the broker eat 'em (gobble, gobble).
Uniform Gift (and Transfer) accounts are also simpler, cheaper, and faster to set up than trusts. You don't need any help from accountants or attorneys. Just use the minor's social security number to report income. The person contributing the money to the Uniform accounts can currently contribute up to $10,000 annually to that account without any tax consequences. As a parent, you can contribute up to $10,000 per year into a child's account without being hit with taxes. Now, one thing to keep in mind is that for estate tax purposes, the donor and the custodian of the account (i.e., the one responsible for managing it) should not be the same person.
The biggest disadvantages to Uniform accounts are: (1) there is no way to take the money back, and (2) the fact that it automatically reverts to the child at a specific age -- normally 18 or 21. In most cases, this isn't a problem at all. In select cases, where parents haven't prepared their children for that moola or where their child goes temporarily insane, it can be a problem. After all, if you sock money away for Junior each year, you'd like to know that when he becomes Senior, he isn't going to pitch all that cash into whiskey, then a cult, then really bad REO Speedwagon albums ("Heard it from a friend who, heard it from a friend whoooo, heard it from another, you've been messing around..."). That would be a REAL shame.
Ok, back to business.
Other monies that you can put into the account include income attributable to the minor (allowance, summer job, birthday gifts, etc.) that is taxable. Under current tax law, until the child reaches the age of 14, all but the first $1,300 of this income is taxable at the parent's tax rate. So that first $1,300 each year is very important -- kids should fill it up as often as possible.
Education IRAs are great vehicles for saving for a child's education, too; however, there are income limitations placed on contributors to such accounts as well as a $500 annual limitation on the amount that can be contributed. Education IRAs provide a tax-free investment towards higher education. They may also be transferred among family members.
There are also a few different kinds of formal trusts that could be used as well. If you wish to set up a formal trust, then you need to have an attorney draw up the necessary legal documents, and you're also required to file annual income tax returns for the trust. However, the formal trust does allow you more flexibility in determining when the money in the trust will revert to the donee. It should be noted that such a trust could be set up so that the amounts contributed are eligible for the annual gift tax exclusion.
The final choice is to set up a separate account in the parent's name for the child's benefit. This account will be taxed at the parent's tax rate and can then be used for the child's benefit at a later point in time.
In addition to all the account type choices, there are an incredible number of other considerations as well. One of the most difficult ones is considering the potential ramifications of putting money into an account that will automatically revert to your child when she reaches the age of 18. I know that my wife and I will do all that we can to raise our son the right way, but unfortunately, there are no guarantees that he'll turn 18 and use the money towards his college education. If it's his money, he can really do whatever he wants with it.
Another thing that enters into the equation is that if you put the money into something like a Uniform account now, it will be transferred at its current value. If you invest the money yourself and give it to your child after you've grown the money through your Foolish investments, then it could result in a taxable gift. There are always tax ramifications to consider. Also, there is some benefit to having your child able to earn some money at a low tax rate. Plus, once your child reaches 14, then all the income is taxed at his low tax rate.
The last consideration is that when it comes to financial aid, any assets that are in a child's name are assumed to be for educational purposes. If they're in the name of the parents, then a smaller percentage can be deemed to be for educational purposes -- reducing the chances or size of the financial aid. We sincerely hope to do well enough over the years that we can pay for the education of any of our children, but there are no sure things and, man, college is EXPENSIVE.
After sorting through all this in the Weiss household, we decided to create a Uniform Transfer account with a portion of the money. For now, I don't see any reason to bother with setting up any formal trusts. As for the rest of it, we're keeping it in our name in separate accounts. I don't really expect any of these accounts to generate a lot of taxable income right now -- after all C-Ks are buy and hold investments -- so the tax considerations became less important.
After opening the Uniform Transfer brokerage account for C-K holdings, we transferred one share of some of our Drips to a separate account so that we can track the money we've saved for our child's education separately. We're focusing on buying C-K stocks in companies that sell products that our son will use and enjoy over the years, too. We plan to teach him about these companies as he grows older -- the little guy is doing enough right now to keep more than half of the food on his plate.
I've covered a lot here tonight, but I do think that this is a really important topic. Parents should take some time to sort through this issue, and drop by our community boards to get more information. Working together with your child, you can put together a solid, wonderful account for the years and decades to come.
Have a great evening. I'll be back tomorrow with a very Foolish interview with one of our readers -- I really think you'll enjoy it.
Phil Weiss, Fool
Stock Change Bid AXP -7 3/8 101.06 CHV -1 3/4 76.94 CSCO +3 1/4 99.94 KO +1 1/4 81.63 GPS +2 5/16 61.75 EK +1 3/4 83.00 XON -1 1/4 64.94 GM +1 7/8 70.25 INTC + 3 87.00 MSFT +2 9/16 106.81 PFE - 9/16 105.31 TROW --- 34.38 |
Day Month Year History
C-K +0.85% -1.67% 13.64% 13.64%
S&P: +0.76% -2.77% 8.82% 8.82%
NASDAQ: +2.32% -2.29% 10.69% 10.69%
Cash-King Stocks
Rec'd # Security In At Now Change
2/3/98 24 Microsoft 78.27 106.81 36.47%
2/3/98 22 Pfizer 82.30 105.31 27.96%
5/1/98 37 Gap Inc. 51.09 61.75 20.87%
2/27/98 27 Coca-Cola 69.11 81.63 18.11%
6/23/98 23 Cisco Syst 86.35 99.94 15.74%
2/13/98 22 Intel 84.67 87.00 2.75%
2/6/98 56 T. Rowe Pr 33.67 34.38 2.08%
5/26/98 18 American E 104.07 101.06 -2.89%
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 20 Eastman Ko 63.15 83.00 31.44%
3/12/98 20 Exxon 64.34 64.94 0.94%
3/12/98 17 General Mo 72.41 70.25 -2.98%
3/12/98 15 Chevron 83.34 76.94 -7.69%
Cash-King Stocks
Rec'd # Security In At Value Change
2/3/98 24 Microsoft 1878.45 2563.50 $685.05
2/3/98 22 Pfizer 1810.58 2316.88 $506.30
5/1/98 37 Gap Inc. 1890.33 2284.75 $394.42
2/27/98 27 Coca-Cola 1865.89 2203.88 $337.99
6/23/98 23 Cisco Syst 1985.95 2298.56 $312.61
2/13/98 22 Intel 1862.83 1914.00 $51.17
2/6/98 56 T. Rowe Pr 1885.70 1925.00 $39.30
5/26/98 18 American E 1873.20 1819.13 -$54.08
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 20 Eastman Ko 1262.95 1660.00 $397.05
3/12/98 20 Exxon 1286.70 1298.75 $12.05
3/12/98 17 General Mo 1230.89 1194.25 -$36.64
3/12/98 15 Chevron 1250.14 1154.06 -$96.08
CASH $94.76
TOTAL $22727.51
*The year for the S&P and Nasdaq will be as of 02/03/98
