Kid putting change into a piggy bank labeled UTMA AND UGMA Accounts for kids

Financial Advisors Guide: UTMA And UGMA Accounts For Kids

In the realm of financial planning and estate management, parents and guardians seek various avenues to secure their children’s future. Among these options, Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts stand out as popular tools for gifting assets to minors. These accounts provide a unique framework for transferring assets while maintaining some control over how they are managed until the minor reaches the age of majority. This comprehensive guide will delve into the intricacies of UTMA and UGMA accounts, exploring their benefits, limitations, and key considerations.

Introduction to UTMA and UGMA Accounts

UTMA and UGMA accounts are specialized custodial accounts that allow parents, grandparents, or other benefactors to transfer assets, such as cash, stocks, bonds, real estate, and other investments, to minors without establishing a formal trust. These accounts were established to simplify the process of gifting assets to minors while allowing the custodian to retain some control until the minor reaches adulthood. They are irrevocable gifts to the minor and must be used to benefit the minor if the funds are withdrawn.

At the age of majority, the former minor can come forward to take possession of the account. The age of majority is not necessarily 18 when it comes to UTMA and UGMA accounts. It depends on the state. It can range from 18 – 25, allowing the parent or custodian to manage the money longer. Here is a list to find your state’s age.

The main difference between UTMA and UGMA accounts lies in the types of assets that can be transferred. UTMA accounts allow for a broader range of assets, including real estate, art, and intellectual property. In contrast, UGMA accounts primarily involve financial assets such as cash, stocks, and bonds. UTMA accounts are the newer style and are available in all states except Vermont and South Carolina. UGMA accounts are available in all states.

Related: 14 Money Lessons For High School Students

What’s the difference between a savings account and a UTMA or UGMA account?

Well, in some respects, they are one and the same. Your bank may offer UTMA and UGMA accounts for your minor where you can deposit cash and receive interest. However, there are also kid saving accounts, a distinctly different entity. The parent and child jointly own these savings accounts. There are some perks some banks will include, such as they may educate children on money and provide teenagers with debit cards.

One big difference between a kid savings account and a UTMA or UGMA account is that the minor can access the funds in the savings account. UTMA and UGMA accounts are custodial accounts where the parent or custodian controls the money or investments until the child reaches the majority. The second difference is that a kids’ savings account only holds cash, whereas UTMA and UGMA accounts can contain other types of investments.

Benefits of UTMA and UGMA Accounts

Simplicity of Setup: One of the primary advantages of UTMA and UGMA accounts is their relative ease of setup. Establishing a trust can be a complex and expensive process, whereas creating a custodial account under UTMA or UGMA guidelines is relatively straightforward.
Tax Advantages: Contributions to UTMA and UGMA accounts are considered gifts for tax purposes, and there may be potential tax benefits associated with gifting assets to minors. These accounts can allow for some tax savings, as the minor’s lower tax rate is often applied to any income generated within the account.
Control and Management: Until the minor reaches the age of majority, the custodian (usually the parent or guardian) maintains control over the assets within the account. This control allows for decisions related to investments, withdrawals, and management of the assets to be made in alignment with the minor’s best interests.
Growth: UTMA and UGMA accounts can serve as a vehicle for saving and investing for a child’s wedding, first car, education expenses, etc. As the investments potentially grow over time, they can contribute to covering the costs and offsetting inflation, reducing the financial burden on the child and their family.
Flexible: These accounts allow for unlimited contributions and withdrawals. There are no limits on AGI (adjusted gross income) for parents or any other donor that wants to contribute to the account. Another flexible component is that the funds can be used for any purpose.

Key Considerations and Limitations

While UTMA and UGMA accounts offer several advantages, there are also important considerations and limitations to keep in mind:

Age of Majority: One critical aspect of these accounts is the age at which the minor gains complete control over the assets. In most states, the age of majority is 18 or 21, depending on the type of account and the state’s specific laws. Once the minor reaches this age, they gain complete control over the assets, and the custodian’s authority is terminated.
Tax Implications: While potential tax advantages are associated with these accounts, it’s important to be aware of the “Kiddie Tax.” This tax rule applies to unearned income (such as interest, dividends, and capital gains) above a certain threshold for children under a certain age. The Kiddie Tax can result in higher tax rates on unearned income, potentially offsetting some of the tax benefits of UTMA and UGMA accounts.
Irrevocable Gift: Once assets are transferred to a UTMA or UGMA account, they are irrevocably designated for the minor’s benefit. The benefactor cannot reclaim or redirect the assets for personal use, even in cases of financial hardship or changing circumstances.
Financial Aid Considerations: When it comes to financial aid for college, assets held in UTMA and UGMA accounts are considered part of the student’s assets and can impact eligibility for need-based financial aid.

Managing UTMA and UGMA Accounts

Effectively managing UTMA and UGMA accounts requires careful consideration and planning:

Investment Strategy: The custodian should develop a well-thought-out investment strategy that aligns with the minor’s long-term goals and risk tolerance. Balancing growth potential with risk management is essential.
Regular Review: It’s important to periodically review the account’s performance and adjust the investment strategy as needed. As the minor approaches the age of majority, the investment approach may shift to a more conservative stance.
Education Planning: If the account is intended to fund the minor’s education, it’s crucial to estimate future education expenses and adjust the investment strategy to meet those goals. You may also want to consider a more tax-advantaged education savings account. What college savings plan is the best?
Communication: Open communication with the minor about the account’s purpose, value, and potential uses can help educate them about financial responsibility and provide a smoother transition of control when they reach the age of majority.

High-Level Summary

UTMA and UGMA accounts offer a valuable means of transferring assets to minors while retaining a degree of control over their management. These custodial accounts can play a significant role in funding major expenses, providing financial support, and instilling a sense of financial responsibility in the next generation. However, careful planning and consideration are essential to navigate these accounts’ tax implications, limitations, and changing dynamics.

By understanding the benefits and challenges of UTMA and UGMA accounts, benefactors can make informed decisions that align with their goals for the financial well-being of their children or grandchildren. If you need guidance for your situation, BlackBird Finance specializes in helping families optimize their financial life. Sign up for the newsletter if you are curious, or take the next step and set up a free discovery session.

Related: How To Teach Children About Money

Sources:

Bennett, K. (2023, August 7). How to open a savings account for a child. Bankrate. https://www.bankrate.com/banking/savings/should-your-child-have-a-savings-account/#types-of-kids-bank-accounts

Segal, T. (2023, April 30). What is a custodial account?. Investopedia. https://www.investopedia.com/terms/c/custodialaccount.asp