UGMA/UTMA Accounts: Smart Ways to Secure Your Child’s Future
Custodial accounts may help you secure your child’s future.
As a parent, you may face challenges preparing your child for the future, especially regarding money. Opening a savings account at your bank is a good start, but there are other options that may help maximize savings and set your child on a path to financial success.
UGMA and UTMA accounts, so named for the Uniform Gifts to Minors Act and Uniform Transfers to Minors Act that created them, are custodial accounts that parents and guardians open in their children’s names to help financially prepare them for the future. Let’s explore how these accounts work.
UGMA and UTMA accounts help you build savings for your child that they receive when they reach the age of majority.
These accounts have no restrictions on how your child may use the money once it transfers to them.
There are no contribution limits on these accounts, helping you save as much as you’re able to set aside without issue each year.
What Are UGMA and UTMA Accounts?
The Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) regulate the transfer of cash, property, and assets to minors.1
Parents or guardians open these custodial accounts to build savings for a minor’s future and transfer assets without needing a trust. Once assets are in an UGMA or UTMA account, they can’t be revoked.2 Funds in these accounts may be invested in other assets to potentially grow the account’s value.
A custodian, typically the parent or guardian, manages the account until the minor reaches the age of majority, which varies by state, often at 18 or 21.3 At that point, the assets become the child’s and they’re free to use them for any purpose.
UGMA Vs. UTMA Accounts
Though UGMA and UTMA accounts are similar, there are a few key differences you need to know about which relate to the types of assets that you’re able to transfer.
UGMA accounts only allow for financial products to be transferred, including4 :
UTMA accounts, on the other hand, are a bit more flexible. In addition to transferring financial products, you may also transfer5 :
If you’re unsure which account would work best for transferring assets to your child, consult a financial expert.
Note that Vermont and South Carolina have not adopted the Uniform Transfers to Minors Act, meaning residents in these states are only able to open UGMA accounts.6
Opening a Custodial Account
Any U.S. resident over 18 may open an UGMA or UTMA account, usually at a bank or brokerage firm. Each bank and brokerage firm have their own opening deposit requirements, so check their guidelines to find out how much you need to open an account.
After opening, you may be able to invest in various investments which may include7:
Exchange-traded funds (ETFs)
Certificates of deposit
While these funds may be used for college expenses, remember that the assets belong to the student and may impact their financial aid eligibility.
Taxes and Contribution Limits
One major benefit of these accounts is the absence of contribution limits, unlike some other college saving funds. However, keep in mind that contributions are considered gifts and aren’t tax-deductible.
Additionally, be aware that if you exceed the IRS’ gift tax limit, you could be subject to federal gift taxes. For 2023, the limit is $17,000, allowing you to contribute up to $17,000 without worrying about the federal gift tax.8 Just be aware there is also a lifetime gift tax exemption limit of $12.92 million as of 2023.9
Furthermore, assets and earnings in these accounts aren’t considered income on the custodian’s taxes. Since the account is registered in the minor’s name, it’s reported for taxes using their Social Security number. Depending on your financial situation, this could potentially reduce your tax liability since your child’s tax bracket is likely lower than yours.10 As always, it’s best to consult a tax advisor on these matters.
Withdrawing from an UGMA or UTMA Account
Once the child reaches adulthood in their state, they take ownership of the UGMA or UTMA account and may use the funds however they wish, such as higher education, starting a business, or purchasing a home.
Before the child gains control, the custodian may withdraw funds from the account if they’re used for expenses benefitting the child.11 If you’re considering withdrawing funds on your child’s behalf, consult with a financial advisor to make sure you’re using the funds appropriately.
UGMA/UTMA Accounts Vs. 529 Plans
If you’re saving for your child’s college fund, it’s important to understand how these accounts compare to a dedicated college savings plan, like the 529 plan.
UGMA and UTMA accounts offer more flexibility as the funds may be used for any purpose, not just college expenses. In contrast, 529 plans are restricted to qualifying educational expenses to avoid federal tax penalties.
Tax-wise, 529 plan funds remain tax-free when used for eligible educational costs, such as tuition, housing, and supplies.12 UGMA and UTMA account earnings, however, are subject to taxation. Since these accounts belong to the minor, the minor must report and pay taxes on the annual investment income.13 However most children have minimal income, resulting in relatively low taxes on these earnings while they’re minors.
Pros and Cons of UGMA and UTMA Accounts
Though UGMA and UTMA accounts may help you build savings for your child’s future, you want to understand the pros and cons of these accounts.
Pros of Custodial Accounts
Let’s review a few benefits you and your child may see if you open an UGMA or UTMA account:
Flexibility of use: UGMA and UTMA funds can be used for any expense once the minor reaches adulthood.
Tax benefits: The money in the accounts is taxed at your child’s tax bracket, which may allow you to save on your income taxes.
Easy to set up: Many banks and brokerage firms offer UGMA and UTMA accounts. And though these accounts are considered trusts by law, they don’t require the complicated (and expensive) legal setup.14
No contribution limits: There is no limit to the amount you may contribute to the accounts each year.
No withdrawal restrictions: Once the minor reaches the age of majority, they may use the money however they see fit. This means they can use the funds to pay for college, save for retirement, or buy a car.
Cons of Custodial Accounts
Let’s take a moment to consider a few potential drawbacks you may encounter with an UTMA or UGMA account.
Lack of control: Once the minor reaches the age of majority, they may use the funds however they see fit. The custodian no longer has control over the funds once they transfer assets to the accounts.
Tax implications: Since the money belongs to the minor, they’re responsible for taxes on the funds, both before and after reaching adulthood.
Irrevocable gifts: The money you contribute to the account becomes the property of the minor as soon as you make the contribution.
Financial aid impact: Since these accounts belong to your child, it may impact their financial aid eligibility depending on the institution they attend.
Is a Custodial Account Right for Me?
UGMA and UTMA accounts may make it easier for parents and guardians to transfer assets to minors and give them flexibility with the funds once they become adults.
When deciding what type of account to open to help save for your child’s future you have a few considerations to keep in mind.
How much control do you want? If you’re worried about your child’s money management skills, a 529 plan or other college savings account may be a good fit. But if you’re confident in that your child is responsible, an UGMA or UTMA account may work well.
What assets are you trying to transfer? College savings plans generally only allow cash contributions, whereas UGMA and UTMA accounts allow you to transfer other assets, such as stocks, bonds, and property.
Could you need these funds? If you may require access to funds for your own needs, these accounts may not be the right choice for you. A savings account with your child as a joint owner may be a better option.
If you have questions about your specific situation, consult a financial advisor who can review your goals and help you outline a plan.
UGMA and UTMA accounts offer a way to save for your child’s future while giving them the flexibility to use the funds for education or other expenses when they become adults. While these accounts offer several benefits, they don’t offer the same tax benefits as dedicated college savings accounts like 529 plans.
While these accounts offer a unique opportunity to help set your child up for future success, it’s important to help your child understand the responsibilities associated with these funds once they become adults. Take time to discuss finances with them to help prepare them for the responsibility associated with these funds when they become adults.