Helping a Family Member Save for College

My brother and sister-in-law are expecting a baby girl in a few months, and I’d like to set up a custodial account or a 529 college-savings plan for my niece. Can I establish an account for her now, or do I need to wait until she is born? And can I set up a custodial account for her, even though I’m not her parent? What’s the best way to go about this?

Yes, even though you aren’t her parent, you can set up a custodial account or a 529 for your niece, but you’ll have to wait until she is born and has a Social Security number before you can open the account in her name.

You can set up a custodial account with a brokerage firm or mutual fund company and can appoint either yourself or someone else (such as the child’s parents) to be the custodian for the account. The custodian manages the assets in the account until the child reaches the age of majority (age 21 in most states; 18 in a few) and takes control of the money. Until then, the custodian can also withdraw money from the account for anything to benefit the child (not just for college expenses). If you don’t want that responsibility, you can just be the donor -- opening the account and contributing to it, and appointing the parents as the custodians. See Teaching Kids About Investing for more information about custodial accounts and a list of some brokerage firms and fund companies with low fees.

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Any contributions to the custodial account are considered to be an irrevocable gift to the minor that you cannot take back. The taxes on interest, dividends and capital gains are the responsibility of the minor (or the minor’s parents), even before the child reaches the age of majority. For more information about taxes and custodial accounts, see Kids, Stock and Taxes.

If you contribute more than $13,000 to the child’s custodial account in 2011 (or $26,000 from a married couple), you could be subject to gift taxes.

Or you could open a 529 college-savings plan for your niece as soon as she is born and has a Social Security number. The money in the 529 can be used tax-free for college costs, and you may be able to get a state tax break, depending on where you live. About half the states offer an income-tax deduction for contributions, and you generally need to contribute to your own state’s plan to get the deduction (although five states let you deduct contributions to any state’s plan). In some states, you need to be the account owner in order to take the deduction. If that’s the case in your state, you can open up a separate 529 for your niece so you can qualify for the tax break, even if the parents already have an account open for her -- there’s no limit to the number of accounts that can be opened for one child. See Give the Gift of a 529 Plan Contribution for more information.

There’s a special gift-tax break for 529 contributions -- you can make five years’ worth of 529 contributions ($65,000 per child, or a married couple can contribute up to $130,000 per child) -- all in one year without triggering the gift tax, as long as you don’t give that person any other money within five years.

If you’re really eager to start investing for your niece, there is a way to contribute to a 529 before the child is born. You can open an account now and make the child’s parents or other eligible relative the beneficiary. Then you can change the beneficiary to your niece after you get her Social Security number. See the Qualified Tuition Program section of IRS Publication 970 for information about switching 529 beneficiaries.

For more information about financial gifts to kids, see 6 Tax-Smart Ways to Help Your Kids (or Grandkids).