Created in 1956, UGMA Accounts are the oldest form of tax-advantaged custodial accounts. UTMA accounts were created in 1986 and are a special flavor of UGMA.
These days, 529 packages and education savings accounts are common ways to save for higher education. However, Uniform Gift to Minors Act Accounts, UGMA, and later Uniform Transfers to Minors Act Accounts, UTMA, were once considered the primary means of saving for children’s college education.
Despite their rarity, UGMA accounts and UTMA accounts still offer a flexible investment account for children. An adult can invest for the benefit of a child until the child takes over the account between the ages of 18 and 21.
Here’s what you need to know about this class of custodial accounts.
What are deposit accounts for minors?
Deposit accounts are investment accounts where an adult saves and invests money on behalf of another person. Parents and grandparents often use it to help their children pay for collegebuy a house or pay for a wedding, to name a few.
These accounts do not offer the same tax benefits as 529 and Education savings accountsbut they offer more flexibility to the beneficiary once they have taken over the account.
Uniform Gifts to Minors Act (UGMA) and Uniform Minors Transfer Accounts (UTMA)
Both UGMA and UTMA accounts are securities accounts intended to transfer assets to minors.
The main difference between the two is the type of assets allowed in each account. UGMA accounts only allow financial assets such as cash, stocks, and mutual funds.
UTMA accounts allow all tangible assets including cars, jewelry, real estate, etc. If you have important alternative investments want to pass on to your children, a UTMA account may be the best way to do it.
Remember that UTMA accounts are not allowed in Guam, South Carolina, Vermont, or the Virgin Islands.
In general, recipients will take over UGMA and UTMA accounts between the ages of 18 and 21. However, many states have higher age of majority limits for UTMA accounts than for UGMA accounts.
Although the accounts offer no tax benefit by contributing to the account, parents can benefit from a small income tax break.
Unearned interest in a child’s investments is subject to tax rules for children. In 2023, the Kiddie Tax Rule will provide a small shelter on up to $2,500 earned in an investment account owned by a minor (including an UGMA).
Once the beneficiary reaches the age of majority, they resume their UGMA account. After that they can use the money for whatever they want. The beneficiary could use it for education, but they could also use the assets to start a business or take a trip to Hawaii. The original investor has no say in the funds once the beneficiary takes over the account.
UGMA and UTMA Account Rules
UGMA/UTMA accounts have fewer rules than 529 plans or college savings accounts. However, adults should be careful to manage these accounts properly.
Donors should remember that accounts are subject to gift tax limits. In 2023, you cannot deposit more than $17,000 in a custodial account without reporting gift tax on the additional gift.
The account owner (often the parents or grandparents) will pay taxes on income earned in a UGMA or UTMA account. The Kiddie Tax Rule reduces the overall tax burden on investment income, but the account holder still has to pay taxes on the income.
Perhaps the most important rule for parents to remember is that this account is an unconditional wealth transfer. When the beneficiary reaches the age of 18 to 21, the account belongs to him. They can do whatever they want with the money.
If this is important to you and you aren’t too concerned about tax benefits, for example, earnings from a 529 plan grow sheltered from federal tax, giving your funds the ability to accumulate faster. If you just want to pass assets on to your child, a UGMA or UTMA might be a good option.
Don’t forget the gift tax limits.