She may be under 18 but your child may still be liable for taxes on her savings account. Families are liable for taxes on savings account interest if interest and dividends exceed $1,000. However, a 529 savings plan earns interest and dividends tax free, as long as the proceeds are used for her education. UGMA, UTMA and Roth IRA accounts are other savings options that bring tax benefits.
Traditional Savings Accounts
If your child has a standard savings account through a financial institution, you're potentially liable to pay taxes on the interest she receives. According to the Internal Revenue Service, a dependent child must file a tax return if she has unearned income, such as interest and dividends, of more than $1,000. If she has unearned income over $2,000, she must file a tax return and the income is taxed at the parent's highest tax rate. Assuming she doesn't have income from a job or business, she won't have to file a tax return if interest and dividends are less than $1,000 annually.
A tax-savvy alternative to a standard savings account for your child is a 529 plan. In a 529 plan, all gains are deferred and tax-free as long as the proceeds are used to pay for tuition. The funds can pay for either undergraduate or graduate studies and can be used at both traditional universities and community colleges. If you spend any of the proceeds on something other than tuition, you must pay both regular income tax and a 10 percent penalty on the plan earnings.
UGMA and UTMA Accounts
If you'd prefer to purchase investments on behalf of your child rather than just depositing funds in her name, consider a UGMA or a UTMA. Uniform Gifts to Minors and Uniform Transfers to Minors are accounts that allow children to own investments and property, like stocks, bonds, real estate and mutual funds. The first $950 in gains in these accounts are tax free and the second $950 is taxed at the child's tax rate rate. Unlike the 529 plan, parents can spend the account funds however they please. Once the child is of age -- either 18 or 21, depending on your state -- the account will be transferred to her name and she can use the funds how she pleases.
If your child is already earning income from a part-time or seasonal job, a Roth IRA can offer more tax savings than a regular savings account. Children put wages into the IRA after they've been taxed, but wages will grow tax free from that point. As long as the child doesn't make any withdrawals until she's 59 and a half, she won't incur any penalties and won't pay taxes on IRA earnings.
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