Parents want to set their children up for financial success.
But, some parents may not feel confident about the best way to do that. And with a range of available options, from saving in a bank account to funding a 529 college savings plan and establishing a custodial brokerage account, parents have to decide what works best for them and their children.
This is where UTMA (Uniform Transfer to Minors Act) and UGMA (Uniform Gift to Minors Act) accounts come into play.
UTMA and UGMA are flexible investment accounts you can establish for your children to save and invest on their behalf. While they may be great for some, there are a few caveats to consider before signing up.
Here are 5 Essential Things to Know About UTMA and UGMA Accounts
Navigating UTMAs and UGMAs can be tricky. Here are five things you should know before going any further.
1. They are easy to establish and fund
UTMA and UGMA accounts can offer an easy path when saving for your child’s future.
With the rise of online brokerages, setting up and funding your child’s UTMA or UGMA account can be done in minutes. This is a huge benefit for busy parents who don’t want to jump through a series of hoops.
Furthermore, most major brokerages and custodians offer UTMA* and UGMA accounts, though they may be called custodial brokerage accounts.
*All states allow UGMA accounts, but not all allow UTMA accounts—be sure to check your specific state laws for additional information.
2. They offer a lot of flexibility
One key benefit of UGMA and UTMA accounts is the flexibility they offer.
While many parents choose to save in a 529 college plan for their children, some grapple with the possibility that their child may not go to college. Unfortunately, this can lead to a situation where you’ve set your child up for financial success, but they can’t use the money for anything but college without incurring penalties.
UTMA and UGMA accounts have no specific savings designation. As a result, your child can use the funds for anything: from down payment on their first home to taking a gap year to backpack Europe. In addition, UGMA and UTMA accounts typically offer more investment options than your standard 529 college plan.
One key difference between UTMA and UGMA accounts is that UGMAs are limited to financial products only: stocks, bonds, mutual funds, and other securities. Alternatively, UTMAs can hold any property, from a car to a home and everything in between.
3. There are no tax advantages
One downside to UTMA and UGMA is that they have no tax advantages.
Unlike a 529 plan, where investments grow and distribute tax-free when used for qualified education expenses, UTMA and UGMA accounts have no unique tax advantages to consider. From a tax perspective, they are no different than a regular taxable brokerage account.
This means all interest, dividends, and capital gains are taxable in the year they’re created. But, there’s an interesting caveat: because your child is technically the account owner, the investment income is taxable to them each year, though specific exclusions apply.
Tax rules and limits change over time, so check the IRS for the most current information. In 2022, the first $1,150 of your child’s unearned (investment) income was tax-free. The next $1,150 is taxed at your child’s income tax rate. Then, everything over that can be taxed at your marginal tax rate, often referred to as the Kiddie Tax.
It’s essential to keep this in mind as you’re evaluating the different savings options available and weighing the pros and cons of each.
4. You don’t own the assets—your child does
You are the custodian of UTMA and UGMA accounts, but your child is the beneficiary and owner.
When your child reaches the age of majority (18 or 21, depending on your state), they can use the account however they choose. For some, this works perfectly as their children have developed the skills and tools they need for healthy money management. But, for others, this can create an issue if their children are not well-equipped to manage the funds.
In addition, because your children own the fund, it can significantly impact their financial aid application (FAFSA) than if you owned it. When filling out an application for financial aid, assets owned by the student are given more weight than assets owned by the parents. This can make it harder for your child to get valuable financial aid.
5. The contributions and beneficiaries are irrevocable
Lastly, contributions to UGMa and UTMA accounts are irreversible, and beneficiaries aren’t interchangeable. Once you contribute to your child’s UTMA or UGMA account, that money is theirs to keep.
Generally, funds can only be withdrawn once the child reaches the appropriate age and they can do so themselves. That said, you may be able to use some of the assets for “the use and benefit of the minor,” but proceed with caution as there are potential legal ramifications of misusing the funds.
In addition, because of how these accounts are structured, you have a fiduciary duty to your child as custodian. You must act in their best interest at all times regarding the management of their funds.
This differs from a 529 college savings plan, where you can transfer the account from one beneficiary to another as needed, as long as they are related to the preceding beneficiary. For example, you can establish a 529 plan for your oldest child, use the funds to pay for their college expenses, transfer the remaining funds to your next child for college, and so on.
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Nick trains and develops families in creating, maintaining, and growing wealth. This includes educating clients on the science and academics of investing, comprehensive financial planning, and ongoing coaching to ensure discipline for a lifetime. Nick has seen this create incredible levels of freedom, fulfillment, and love for the families he works with.