UTMA & UGMA Custodial Accounts: How They Work, Benefits
A UTMA or UGMA custodial account is a flexible investment account that helps minors save and invest.
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A UTMA or UGMA account is a taxable investment account that an adult custodian (parent, guardian, relative, etc.) controls on behalf of a minor until the child becomes a legal adult. At that point, the child gets control of the account.
UTMA vs. UGMA accounts
UTMA or UGMA accounts are named after the laws that made them possible. UTMA stands for Uniform Transfer to Minors Act. UGMA stands for Uniform Gifts to Minors Act. UGMA came first and is valid in all 50 U.S. states. It allows gifts of cash or securities to be given to minors without tax implications up to gift tax limits. UTMA came after and expanded gifts to include property and other transfers for those states that have adopted it (all U.S. states except South Carolina and Vermont).
How does an UGMA or UTMA account work?
As a parent or guardian, planning for your child’s needs is top of mind. A lot of times, this leads to a conversation about saving for college, but focusing solely on saving for future education expenses might not be the best fit for every child. Enter the UTMA or UGMA account, also known as the custodial account.
The UGMA or UTMA custodian invests and manages the account, but only the minor can use or benefit from it.
The UGMA or UTMA account and the assets in it are irrevocable and are property of the minor.
The minor is responsible for paying taxes on any investment income the UGMA or UTMA account earns. (Learn more about how the kiddie tax works.)
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Advantages and disadvantages of UGMA and UTMA accounts
There are many upsides and downsides to UGMA and UTMA accounts.
Flexibility.
Can be cheaper and faster than setting up a trust.
No annual contribution limit.
No control once the child becomes adult.
Contributions are irrevocable; can't change the beneficiary.
Account earnings may be taxable.
Can significantly reduce financial aid eligibility.
Flexibility
Not everyone ends up attending college. Perhaps a child is better suited for an apprenticeship or to take over the family business. Or, you may want the child to take out a loan and be responsible for covering the cost of their educational expenses. The UTMA or UGMA account helps a minor save and invest while providing flexibility.
» MORE: Learn how Trump accounts work
Relative ease of account setup
Another perk of UTMA and UGMA accounts is sidestepping the need to set up a trust when giving assets to and managing assets for your child or another minor. The custodian handles and invests the account assets in the best interest of the beneficiary.
Irrevocability
A parent cannot withdraw money from an UTMA or UGMA account once the money goes into the account. Contributions are irrevocable. A parent also cannot change the beneficiary on the account.
Control
Once the child turns the age of majority, the account assets are theirs. Depending upon the amount of assets and the child, this could be a significant financial responsibility to take on. Even if your intention was for the money to go toward education, nothing prevents the child from purchasing their first motorcycle and riding off into the sunset instead. In contrast, a trust may provide more control and rein in undesirable spending.
Financial aid impact
UTMA and UGMA account assets are legal property of the child, which has an affect when it comes to applying for college financial aid. The child’s eligibility for aid may be reduced by 20% of their UTMA or UGMA account asset value. In comparison, 529s and Coverdell accounts reduce aid by only up to 5.64% of the asset value because these plans are considered property of the account owner.
Is an UGMA or UTMA account better than a 529?
Comparing UTMA or UGMA accounts with 529s or Coverdell education savings accounts (ESAs) can help you narrow down the best option for your situation.
UTMA/UGMA | 529 | |
|---|---|---|
Allowed uses | Anything. | Qualified educational expenses only. |
Contribution limits | None. | Yes. |
Tax-deductibility of contributions | None. | No federal deduction; some state deductions may be available. |
Taxability | Account's earnings are taxable. | Account's earnings are not taxable if money is used for education. |
Revocability | Cannot remove assets or change the beneficiary. | 10% penalty to remove assets if not for education; can change beneficiary. |
Both 529s and Coverdell ESAs are meant to be used for qualified educational expenses (tuition, books, etc.). If not, withdrawals are subject to a 10% federal penalty. There are no use requirements for withdrawals from UTMA and UGMA accounts.
529s and Coverdell ESAs are subject to contribution limits. There are no annual contribution limits for 529s, but there are aggregate contribution limits. Coverdells have annual contribution limits and income-based eligibility restrictions. UTMA and UGMA accounts do not have any limitations on contributions.
529s and Coverdell ESAs provide tax-advantaged growth, whereas UTMA and UGMA contributions are taxable accounts. With 529s, the beneficiary can be changed to another if the current beneficiary doesn’t need the money, which is not possible with UTMA and UGMA accounts.
Parents of children with disabilities might want to invest to make sure their children are taken care of financially. ABLE accounts are tax-free savings vehicles that can be an effective option.
» MORE: How to gift 529 contributions
How to get started with a UGMA or UTMA account
If you’re ready to get started with a UTMA or UGMA account, we’ve outlined the process of opening a custodial account and answered some frequently asked questions.
