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An UTMA (Uniform Transfer to Minors Act) or UGMA (Uniform Gift to Minors Act) custodial account could be a good way to invest in your child’s future.
By opening an UTMA or UGMA, you can invest money and watch your child’s savings grow. Your child can use the funds to pay for college as they might with a 529 plan, but they can also spend the money on expenses other than education.
You may want to open an UTMA/UGMA if you:
You may not want to open an UTMA/UGMA if you:
UTMAs/UGMAs are custodial accounts, and the assets are “irrevocable gifts.”
This means the account technically belongs to the child, not to the adult who sets up the account. Any contributions and earnings are considered gifts to the child that can’t be taken away.
When you set up an UTMA/UGMA for your child, you don’t own the account. You can’t use the funds for anyone other than the child, and you can’t transfer the account to yourself or to another child.
An UTMA/UGMA has some benefits over a traditional savings account, because your contributions have the potential to grow.
“The idea is, it’s an irrevocable gift where we can put money into the market and it grows, keeps up with inflation, has exposure to different market environments,” Dexter Wyckoff, a financial planner for Northwestern Mutual, told Business Insider.
Your child will have access to the account when they turn the age of majority. The age of majority varies by state, but in most cases, it’s 18 or 21 in the US. Once the child owns the account, it’s no longer an UTMA/UGMA — it becomes a taxable brokerage account, and the rules for a taxable brokerage account then apply.
Trying to decide between an UTMA and UGMA? The two accounts are very similar, but they have two key distinctions: where you can open an account, and whether you can contribute real assets.
UGMAs are available in all 50 US states, but you can’t open an UTMA in South Carolina or Vermont. If you live in either of these states, you’ll have to go with an UGMA.
Your contributions into an UGMA are more limited than with an UTMA.
“You can buy stocks, you can buy bonds,” Wyckoff said, “you can have a savings account, you can invest in mutual funds … but I could never put property into an UGMA account. I could never put a car into an UGMA account.”
You can put real assets, like property and cars, into an UTMA account, though.
“One of the reasons why we do this is because an irrevocable gift is protected from my creditors and other family members or things like that,” Wyckoff said. “So a lot of times, there’s a situation where there’s a big estate, and the child just isn’t at the point where they can make their own decisions, but they have a parent pass away. Sometimes people will transfer real assets into an UTMA so that it is the child’s, it is protected from creditors, and it is irrevocable.”
You could leave real assets to your child with a trust — but an UTMA could be a better option for people who can’t or don’t want to go through the legal process of setting up a trust.
“Not all families are in position to put trusts in place,” Wyckoff said. “There’s a legal process you have to go through sometimes, and it’s expensive. The UTMA is literally a designation that has been created for us by the IRS. And you just open the UTMA, and you assign the asset to it. Simple.”
You may choose to use an UTMA/UGMA as a college savings plan, as you would with a state-sponsored 529 savings plan. But UTMAs/UGMAs provide much more spending flexibility than 529 plans. You don’t have to use the funds for educational purposes — you can use them for anything that benefits the child, from birthday parties to music lessons to summer camps.
“The IRS just would want to substantiate that it was for the benefit of the child, because it is an irrevocable gift,” Wyckoff said.
This flexibility is good if you aren’t sure your child will need funding for college. Maybe your child doesn’t go to college, or maybe they receive a full scholarship. This way, your kid can still benefit from the account regardless of which path they take in life.
Any UTMA/UGMA rules about spending money become moot once the account is transferred the child at the age of majority.
“It’s no longer an UTMA/UGMA, it’s just a taxable brokerage account, and they can use the money for whatever they want,” Wyckoff said. “The restrictions are while the parent is controlling the assets for the minor.”
An UTMA/UGMA is subject to what’s known as the “kiddie tax.”
If the child’s unearned income — such as income from interest or dividends in the account — is below $2,200 in a year, you’ll pay taxes for the child’s tax bracket for trusts and estates, which for most people is low or even nothing.
If the child’s unearned income exceeds $2,200, you’ll likely have to pay taxes on the unearned income, according to the tax brackets for estates and trusts for the parent.
If your child’s only income is unearned and it totals less than $11,000 in a year, you have the option to include the amount in your annual tax return rather than file a separate return for the child.
Taxes can be difficult for many people to understand, so Wyckoff recommended people talk to a financial adviser and/or tax specialist before opening an account.
If your child attends college, you may need to fill out the FAFSA for them to receive financial aid.
On the FAFSA, you’ll list a) parents’ assets, and b) the child’s assets. The FAFSA assumes you’ll use 20% of the child’s assets to pay for college; it assumes parents’ contributions on a bracketed system, with the maximum assumption of just 5.64%. So a child could receive less financial aid with an UTMA/UGMA than if the only assets held and listed belong to their parents.
You do have the option to convert an UTMA/UGMA into a 529 plan so you can list it as a parental asset. You’ll likely want to speak with a financial adviser before converting, though, because there are pros and cons to taking this step.