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This is a variation on Strategies for putting away money for a child's future (college, etc.)?

My question regards money gifted to a kid (by a family member in this case). What should I consider in choosing a vehicle for investing the money on his behalf? I am not asking for asset allocation advice, purely vehicles. Right now I'm considering:

  • Roth IRA
  • Custodial 529 (owned by the kid with himself as a beneficiary)
  • Simple investment fund

Right now my preference is for the Roth IRA or custodial 529 because I want to reduce the likelihood that he would blow the money when he turns 18 (but the amount is not large enough to justify a trust fund, plus it's his money). Genetics and family culture suggest strongly that the kid will pursue some kind of higher ed, though of course we don't know anything for certain.

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JDelage
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2 Answers2

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Roth is currently not an option, unless you can manage to document income. At 6, this would be difficult but not impossible. My daughter was babysitting at 10, that's when we started her Roth.

The 529 is the only option listed that offers the protection of not permitting an 18 year old to "blow the money." But only if you maintain ownership with the child as beneficiary. The downside of the 529 is the limited investment options, extra layer of fees, and the potential to pay tax if the money is withdrawn without child going to college. As you noted, since it's his money already, you should not be the owner of the account. That would be stealing.

The regular account, a UGMA, is his money, but you have to act as custodian. A minor can't trade his own stock account. In that account, you can easily manage it to take advantage of the kiddie tax structure. The first $1000 of realized gains go untaxed, the next $1000 is at his rate, 10%. Above this, is taxed at your rate, with the chance for long tern capital gains at a 15% rate.

When he actually has income, you can deposit the lesser of up to the full income or $5500 into a Roth. This was how we shifted this kind of gift money to my daughter's Roth IRA. $2000 income from sitting permitted her to deposit $2000 in funds to the Roth. The income must be documented, but the dollars don't actually need to be the exact dollars earned. This money grows tax free and the deposits may be withdrawn without penalty. The gains are tax free if taken after age 59-1/2.

Please comment if you'd like me to expand on any piece of this answer.

JoeTaxpayer
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One other advantage of a 529 versus a simple investment account (like an UGMA/UTMA) is that the treatment for the purposes of financial aid is more advantageous (FinAid.org). Even if it is a custodial account (in which the student is both the owner and beneficiary), it is treated as a parental asset when completing the FAFSA. That means the amount that will be considered available each year towards the Estimated Family Contribution (EFC) will be greatly reduced.

To be sure, this does not help with all colleges (often ones that use the CSS/PROFILE in addition to the FAFSA). Some will simply assume that 25% of the 529 will be used each year.

Rick Goldstein
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