by Archie M. Richards, Jr., CFP^®
July 7, 2003

Property cannot be owned outright by a minor. It's held by an adult, usually a parent, as custodian for the child. When the child is 15 or older, the income earned on the investments is taxed to the child. If the child has little other taxable income, the tax rate is low. The child's standard deduction may result in no tax at all.

But in 2003, Congress cut the tax rates on dividends and capital gains for all investors. Taxes on investment income are now lower for everyone. This doesn't eliminate the need for custodianships, but it reduces it.

The disadvantages of custodianships remain significant, as follows:

• When the child is 14 or under, the income earned in the custodianship, over and above $1,500, is taxable to the parents, not the child.

• Custodianships hinder financial aid.

• If you try to take the money back prior to age 21, the child can sue you. Not an ideal path to family harmony.

• At 21, the kid owns the investments outright and can blow them on whatever he likes, not necessarily education.

Wilma writes that, back in 1975, she and her husband bought Series E Savings Bonds. The bonds come due in 2005. The accumulated interest exceeds $50,000, taxable at redemption. Wilma and her husband want the proceeds used for the college education of their grandchildren. She asks whether they should transfer the bonds to the grandchildren before maturity or wait until the interest stops at maturity.

You don't have to redeem the bonds all at once, Wilma. Until maturity, cash them in gradually, as the money is needed.

As to gifting, let's say that tax savings is your goal. You, your children, and your grandchildren all have different levels of income. If you and your husband have the lowest tax bracket, cash the bonds yourselves, pay the tax on the interest, and gift the proceeds. If your children have the lowest tax brackets, gift the bonds to them. Let them redeem and pay the taxes. The less the tax, the more for education.

If your minor grandchildren have the lowest tax brackets, you could gift the bonds to custodianships. But beware of the disadvantages explained above.

Wilma's Series E Bonds, as mentioned, were acquired decades ago. But readers who acquired Series EE Bonds (a later series) after 1989 have special advantages. They may deduct the interest upon redemption as long as the proceeds of the bonds are used for qualified educational purposes. The bonds must be in the name of the taxpayer, not in the name of the dependent. The deduction is phased out for high-income taxpayers. For more information, see www.publicdebt.treas.gov/sav/sav.htm.

Kitty's father bought a condo half-and-half with his girlfriend. They registered the property as tenants in common. The father later transferred his half to Kitty.

Kitty wants to know who would become the owner on her death. Also, what is the effect of the father's will?

At your death, Kitty, your half of the property becomes owned by the beneficiaries named in your will. If you die without a will, your half would pass to the beneficiaries determined by the laws of your state. Since your father is no longer an owner of the property, his will has no effect.

It's a good thing the condo isn't owned jointly with rights of survivorship. No matter what your will provided, the girlfriend would become owner of the entire property at your death, lock, stock and barrel.

Estelle writes, "What is your opinion of Alpine Realty Income and Growth?"

I have no opinion about Alpine, Estelle. But if you're buying only the stocks of single companies, you take on risk for which you are not compensated. Alpine might hit the skids, while other stocks perform well. Buying too few securities introduces what's called "specific risk." It's undesirable and unnecessary.

Why not buy all real estate investment trusts instead? You can do this via Vanguard's REIT Index Fund or an exchange-traded fund called streetTRACKS Wilshire REIT Index Fund.

Investing in an entire industry is safer.