How to safely raid your kid’s college fund

John W. Schoen Senior producer • Profile • E-mail

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:

“A custodian may deliver or pay to the minor or expend for the minor's benefit so much of the custodial property as the custodian considers advisable for the use and benefit of the minor, without court order and without regard to (i) the duty or ability of the custodian personally or of any other person to support the minor, or (ii) any other income or property of the minor which may be applicable or available for that purpose.”

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.

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