— Tough times call for tough choices. Some cash-strapped parents are wondering: What happens if I need to pull money out of my kid’s college savings account to pay bills?
What steps do I need to take to get back funds put in a UGMA (Uniform Gift to Minor Act) account? My children are doing OK, but we are not. It was meant for college tuition but left untouched and hasn't changed hands after 10 years.
— Rufina T., Address withheld
A lot depends on the age of the child whose name is on the account. If the child is no longer a minor (18 or over in most states), you have very limited options. The money is legally theirs to do with as they choose. The best you can do is ask them for financial help, but it won't matter whether the money they give you comes from the UGMA account or their paycheck.
If the child is under 18, you are still legally the custodian — with a legal responsibility to manage the account for your child’s benefit. But the law that set up these accounts offers a lot of leeway in determining just what that means.
Most states have adopted a newer set of rules (the Uniform Transfers to Minors Act, or UTMA) even though these accounts often go by the old UGMA designation. Setting one up requires special joint registration in name of both the child and a parent or custodial adult. One of the main advantages is that investments in these accounts are taxed at the child’s, usually lower, rate.
If you take money out of the account before the child turns 18, there are some circumstances that could get you in trouble. Cleaning out a custodial account to try to get around limits on college financial aid, for example, could result in criminal fraud charges — typically a federal offense. Using the account simply to shelter money from your higher tax rate could land you in hot water with the IRS.
But there are few restrictions on withdrawing money — as long as it’s being spent for the child’s benefit, according to tax expert Kaye Thomas. He's published an excellent column on alternatives for custodians who suffer what he calls “UTMA regret” — the not uncommon change of heart that some parents experience after they’ve set up one of these accounts. (For parents who may be considering one, Thomas also offers a good overview some of the pitfalls of UTMA accounts.)
In most cases, the simplest solution is to withdraw the money and use it to pay bills to cover the cost of raising your child. Thomas points out that there are no restrictions on which bills you pay — as long as the money is used to support the child whose name is on the account. Here’s what the law says:
In other words, if you’re having trouble paying the mortgage and the grocery bills, and your child is living in your house and eating your food, the law allows you to use the account to help pay those bills.
You’ll probably want to keep records of expenses to show that you’ve applied the custodial funds for only the portion of household expenses required to take care of the child. That may mean having a tax accountant help you manage and document the withdrawals.
There are a few other tax issues to consider with UGMA and UTMA accounts. While the law allows you to make withdrawals, Thomas notes that the IRS may take a dim view of continuing to report investment income at the child’s rate. But this probably won’t cost you much; you’re only paying the higher rate on the income generated — not on the total withdrawal.
You may also lose the child as a dependent on your return, if the money from the UTMA account ends up paying more than half of their living expenses.
For parents with a so-called 529 savings plan, the rules are simpler but will probably cost you more money. These state-by-state programs provide some generous tax advantages to make your savings grow faster. But if you use the money for anything other than educational costs, you have to pay tax on the investment income generated by the account — plus a 10 percent penalty. (Some states have additional penalties.) And if you took a tax deduction for your contributions to the plan, you’ll have to pay that back too.
If you’ve opened a 529 account for a child who doesn’t end up going to college, you can switch the beneficiary to another child or relative and use the money to pay their education expenses. Otherwise, you’ll have to pay the taxes and a penalty to close the account.
The problem now is, I tried to open a checking account at a local bank and was embarrassed to learn that they wouldn't accept me as a client due to the bad history on my credit report. I have been saving $200 per week and have no expenses as I live with my fiancée's family. How do I get these items taken care of quickly? I don't want to negatively affect my future wife's credit.
— Kevin, Brookfield, Conn.
It sounds like it’s too late to sit your parents down and give them a good talking to. Unfortunately, the damage has been done.
Repairing bad credit generally just takes time. The negative impact of late payment or default fades with time. Generally, the worse the problem, the longer it takes. (As for your future wife’s credit, the fast one your parent’s pulled on you shouldn’t have an impact on her — unless the two of you open joint accounts together.)
You may come across various pitches for “credit repair” services and schemes that promise quick results. These are scams. The only thing that’s quick is the demand for an upfront fee for a service that will have no impact on your credit.
Instead, get copies of your credit report from the three credit reporting agencies and check to make sure that the information is accurate. If not, contact the agencies to have it corrected. You can also write a letter to the three agencies explaining what happened and ask that your note be included in your credit file, which they’re required to do.
You may also want to contact an accredited credit counselor in your area who can help you approach lenders that might take your somewhat unusual circumstances into consideration. Lenders make their own decisions about taking on a new customer, and they don’t always come to the same conclusion.