The Downfall of Custodial Accounts?

In Time to Swap Piggybanks, BusinessWeek, Aug. 6, 2007, at 88, Anne Tergesen explains that:

For years, parents have been stashing money in custodial accounts to fund their kids’ college educations. They’ve saved on taxes, too, since a large portion of the bill is paid at the child’s lower rate. But recent changes in the law sap so much of the tax savings from custodial accounts that state-sponsored 529 college savings plans, which are tax-free if used for education, are better deals. In fact, they’re so much better that you may want to cash out your kids’ custodial accounts and put the money in 529s.

How do you decide? Look at how long it is before your child matriculates, the amount of appreciation in the account, and the likelihood of qualifying for financial aid. For most families, “converting to a 529 account makes sense,” says Sam Beardsley, director of investment tax for T. Rowe Price (TROW), a mutual fund company.

Custodial accounts, also known as UGMA/UTMA (Uniform Gifts to Minors Act/Uniform Transfers to Minors Act) accounts, can still be attractive for small sums. The first $850 in annual interest, dividends, and capital gains is tax-free, and the next $850 is subject to a child’s low tax rates. Anything beyond that is assessed at the parents’ marginal rates of up to 35% for interest income and 15% for qualified dividends and capital gains. In the past, once the child turned 14, the parents’ rates no longer applied. But Congress recently extended the parents’ tax rate to age 17 this year and to age 23 for dependent children starting in 2008. “The real benefit of the custodial account is gone,” says Jim Sonneborn, a wealth manager at RegentAtlantic Capital in Chatham, N.J.