My nephew is getting ready to turn 1 year old and I would like to gift him mutual funds. Are there any special types of accounts out there to allow this sort of gifting? I'm not looking to set up a college fund.
One common type of account is called a Uniform Transfer to Minors Act (UTMA) account. Under this type of account, the money is held in the child's name for tax purposes, but the account is under control of a custodian until the child reaches a legal age.
When you set up the account, the amount you put in is considered a gift to the child. The first consideration is the gift tax, which is paid by the giver. You can give him up to $14,000 per year and not have to pay any gift tax on the gift. Above that amount in a year, and there are lifetime exclusions that apply to avoid the tax. Your nephew, as the gift recipient, never has to pay income/gift tax on the gift.
Any mutual fund company should be able to set up a UTMA account. They will need the child's Social Security number, because the funds will belong to him, and he will be receiving tax statements each year on the earnings. You also need to identify the custodian. You could name yourself as the custodian, or you may want to select one of the child's parents. The custodian has complete control of the funds, but is legally required to manage the money in the child's interest. The custodian may choose to continue to invest, or may choose to withdraw the money to pay for something for the child (college tuition, for example).
Once the child reaches the age of majority, the money is completely under his control for any purpose. He could spend it on college, on rent, or he could put it all on red at the roulette table. The age of majority varies in each state, but in Washington State (where I see from your profile that you are located), the age is generally 21.
The child is the owner of the fund for tax purposes. Depending on how much you give him and how much it earns, he might need to start filing tax returns. If he earns enough, he'll be subject to the kiddie tax, which means that his investment income above a certain amount will be taxed at his parents' tax rate. You'll want to make a note of the value of the mutual funds when you bought them, because this will be his cost basis for capital gains tax purposes when he sells the funds. (The gift does not reset the cost basis.)
One other consideration that should be mentioned is that, because the money is in the child's name, it can count against him for need-based financial aid purposes.
Other types of accounts, such as the 529 plans, have tax benefits that the UTMA does not, but they generally require that the money be spent on college.