Question: I have a custodial account for my daughter. She is currently a junior in high school and plans to go to college. I have been told that the money should be transferred out of the custodial account and into my name alone if she plans on applying for financial aid. I’ve heard that money set aside in a custodial account reduces your chances of receiving any financial aid. Can I just re-register this account into my name? Or do I have to liquidate the account and then open one in my name. What are the consequences of doing this?
Answer: Assets in your daughter’s name reduce her eligibility for financial aid. Assets owned by the parents reduce financial aid by up to 5.6% while student assets can reduce financial aid by as much as 20%.
You can’t just take the custodial money and put it in your own account. Assets held in custody for your daughter belong to her, and as the trustee of your daughter’s account, you have a fiduciary responsibility. If you put them in your own account, you are technically taking her money.
Parents are faced with the problem of funding their child’s college education the best way they can, and that often includes financial aid. Your strategy should be to exhaust your daughter’s assets first by using them for tuition, room and board, transportation, computer equipment, and so on. Each year, as she depletes her custodial account, she will qualify for more financial aid. Keep in mind that financial aid is most often given in the form of a loan -- not as an outright gift or grant. It makes more sense for your daughter to use her money to pay for college instead of keeping it in her custodial account and taking out a loan.
If your daughter is working, have her put up to $5,500 of her earnings into a Roth IRA. This could help her qualify for financial aid sooner since IRA assets do not count against her in the financial aid formula. The down side of this strategy might be that if she puts $5,500 into an IRA and gets more financial aid in the form of a loan, is she really ahead? Or is she just borrowing money to fund her IRA?
Another strategy you might hear about is for the custodian (usually the parent) to resign as the trustee of the child’s account. The thinking here is that if the trustee resigns, then the assets in the child’s custodial account will revert back to the parent and the problem will go away. This is probably illegal and in violation of California Probate Code sections 3900-3925, the “California Uniform Transfers to Minors Act.” The act has detailed provisions for what to do when a trustee resigns. Allowing the assets to revert to the parent is not one of those provisions.
The best way to pay for college is to plan ahead by starting when the child is an infant. Invest wisely but aggressively. Use a 529 College Savings Plan and make monthly contributions. A helpful website is SavingForCollege.com. 529 Plans have all the benefits while having none of the disadvantages of any other way to save for college.
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.