If you're looking to save money towards your college costs, two of your choices are a UGMA / UGTA account and a Coverdell education savings account. A custodial account, which is another name for an account organized under the Uniform Gifts to Minors Act or Uniform Transfers to Minors Act, is like any regular account, except that an adult is on the account for you until you become a legal adult. Coverdell accounts are designed for education savings.
UGMA / UTMA Accounts
UGMA and UTMA accounts are both designed to let an adult hold an account for a minor. They're very similar to each other, except that UGMA accounts are limited to bank deposits, stocks and bonds, and insurance policies, while UTMA accounts can hold other assets, such as real estate. In this type of account, once money goes in it becomes the property of the named minor and can only be used for the minor's benefit. Until the minor is an adult, a custodian serves as the signer for the account and has control over it. It reverts to the minor's control when he becomes a legal adult -- usually at age 18 or 21, depending on the jurisdiction.
A Coverdell Education Savings Account, once referred to as an education IRA, is designed to help save for educational expenses. You or your parents can put up to $2,000 per year into the account. You can also invest the money however you want within the rules set up by the financial company that holds the account. As long as you draw the money out for educational expenses -- which include tuition, fees, room, board and supplies -- the withdrawals are tax-free.
One of the key differences between the two types of accounts is how you use them. The Coverdell account is designed for one thing -- to help save for your education -- and using it for other purposes leaves you exposed to penalties. A UGMA / UTMA account can be used for just about anything. If it doesn't get used for college expenses, you can use it as a savings account for a house, for getting married, or even for achieving other long-term goals. Once you become an adult, it becomes a regular investment account.
Both accounts are treated differently under the tax code, although both start out being funded by after-tax money. Your UGMA / UTMA account is your property and gets taxed on your tax return. This means that a portion of the income that it earns every year gets covered by your standard deduction and is tax-free, some gets taxed at your tax rate, and, if you earn enough investment income in it to get hit by the "kiddie" tax, some gets taxed at your parent's rate.
Coverdell accounts, on the other hand, grow tax-free while you aren't using the money. As long as you pull out money for education purposes allowed by the Internal Revenue Service, you don't pay taxes on your earnings, either. If you pull out money for other purposes, though, you have to pay income tax on your earnings and may have to pay an additional 10-percent tax penalty. You'll also have to pay taxes and penalties if you don't use the money for your education or give it to someone else in your family for his education within 30 days after your 30th birthday.
The two accounts can be treated differently for the purposes of calculating your financial aid. Under the federal equation that most schools use, a UGMA / UTMA account is treated as your asset, unless it is also set up under a 529 college savings plan. This means that, as of 2013, you will have to spend 20 percent of its balance towards your school expenses. Coverdell accounts, on the other hand, are considered your parents' asset if they own them for your benefit. This means that such an account has little to no impact on your financial aid award.
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