January 2008

Remember the days when kids were encouraged to plunk away money for the future, especially for a college education?

It seems the federal government has lost the urge to encourage thrift. Starting this year, an expansion of the notorious “kiddie tax” discourages children from having large savings or investment accounts in their own names.

The kiddie tax began in 1986 in order to catch high income parents who were shifting large amounts of money or investments to their children in order to take advantage of the children’s lower income tax rates.

Starting that year children under age 14 who had more than a modest amount of interest or investment income had to pay income tax at either their own tax rates or at their parent’s tax rates, whichever was higher.

But two years ago Congress expanded the tax to children under age 18. Now it has expanded it to a maximum of age 24, if a child is a full-time student and not providing more than one-half of his or her own support.

The limit for a child’s unearned income was $1,700 in 2007: an inflation-adjusted increase for this year has not yet been announced.

So a child better not have more than $34,000 in accounts earning 5%, for example, because the interest over $1,700 may be taxed at the parent’s rate.

Where does this leave families who want to save big money for college?

It is still OK to put some money in a child’s name, but the bulk of the savings should be done in a 529 college savings plan account for those who want the maximum tax advantage.

These accounts defer taxes on earnings and allow them to be used tax-free if withdrawn for college expenses. Plus, they give a parent control over the account after age 21.

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