In prior posts, we have discussed ways to pay for college without having to go into debt with student loans or credit cards. With regards to college savings vehicles, we have discussed 529 plans and Coverdell Education Savings Accounts. Another option for parents and grandparents is to make use of the Uniform Transfers to Minors Act (or Uniform Gifts to Minors Act). The proper use of this savings vehicle will provide tax-free funds for the college student without any limitations on the use of the funds. The easiest way to describe how this works is to use an example.

Let’s say the grandparents of newborn child, Charlie, have the means to put $14,000 in an investment plan for Charlie’s college expenses. The investment plan will be titled in his name “under the Uniform Transfers to Minors Act.” The grandparents name their daughter, Ellen, Charlie’s mother, as the custodian of the account. The $14,000 is invested in a mutual fund that earns 6% per year. The income in the account will be unearned income for Charlie.

The first year, Charlie’s income from the account will be $840. Current law provides that Charlie, who is a dependent of his parents, can earn $1,050 or his earned income plus $350 before any of that income is considered taxable income. In addition, if the income is gain from sale of stocks or other investment property owned longer than a year, or is dividend income from U.S. stocks, the income is taxed at the capital gains rate. Tax practitioners call this income “preferential income.”

However, there is an additional wrinkle in the tax code for Charlie and his parents. If Charlie’s income on the investment account is greater than $2,100 (for 2015) and Charlie is under age 18, or is under age 23 and a student, and his parents claim him as a dependent on their tax return, Charlie will be subject to the “kiddie tax.” Under the kiddie tax rules, any unearned income Charlie has that is greater than $2,100 will be taxed at his parents’ tax rate.

As long as Charlie’s income from the investment account is $2,100 or less each year, $1,050 will not be taxable and the remaining amount, provided it is preferential income, will be taxed at Charlie’s capital gains rate. Charlie’s capital gains rate will be 0% if his regular tax rate is 15% or less. So, if Charlie has no other income and all of the income in the investment account qualifies as preferential income, he will have no tax on the income earned in the account.

With proper planning, it’s possible that Charlie would not have any income tax on the earnings in the account and will have $39,960 of tax-free money for his college expenses – even if he has a job as a teenager. As long as Charlie’s non-preferential income is $350 or less and his total taxable income (income from his job plus his non-preferential income) is below the standard deduction each year, Charlie will not have any taxes due. For 2015, the standard deduction is $6,300.

Even if the parents or grandparents don’t have $14,000 to invest when Charlie is born, the same principle applies with monthly or annual contributions to the account. For example, if the grandparents invested $100 per month, Charlie would have $38,735 for college, all tax-free. To avoid gift tax, the contributions to Charlie’s account must be less than the annual gift tax exclusion each year. For 2015, the exclusion is $14,000 per person.

While the 529 plans and the Coverdell Education Savings Plans limit the use of the money in the accounts to “qualified education expenses,” the funds in the Uniform Gifts to Minors account can be used for any expenses, even those that are not college-related. The possible downside is that when Charlie reaches the age of majority (age 21 in most states), all of the funds in the account must be distributed to him.

Parents and grandparents who desire to help fund their children’s and grandchildren’s college education need to consider all the options available to them and then choose the savings vehicle that best fits their situation. For more information on this savings vehicle or those mentioned in prior posts, please feel free to contact us.

Reference: “Financing for College with Uniform Transfers to Minors Act” by Allen Form and Zac Wiebe and information from

Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.

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