A Guide to UGMA/UTMA Accounts
UGMA/UTMA accounts are a flexible option for saving for a child and may be an excellent complement to your investment accounts. This post dives into what is an UGMA/UTMA account, the pros and cons, how they work, and compares UGMA/UTMA accounts to 529s and taxable brokerage accounts.
What is an UGMA/UTMA account?
Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts, also called “custodial accounts,” allow adults to set aside and manage assets on behalf of a minor until they reach the age of majority (18 or 21, depending on the state).
The terms UGMA or UTMA are often used interchangeably, or investment custodians will simply call the accounts “custodial accounts,” although there is a subtle difference between UGMAs and UTMAs. UGMA accounts are limited to financial assets (cash, investments) and UTMA accounts can hold financial assets plus a broader range of assets (like real estate and tangible property).
UGMA/UTMA accounts offer a flexible way to save and invest for a child’s future. There are no income or contribution limits, and the funds can be used for any purpose that benefits the minor (not just education expenses).
However, UGMA/UTMA accounts also have a few drawbacks, including potential tax considerations and impact on financial aid eligibility.
What are the benefits of an UGMA/UTMA account?
The primary benefits of UGMA/UTMA accounts are flexibility and tax advantages.
Flexibility
UGMA/UTMA accounts offer flexibility in contributions and uses.
There are no contribution limits to UGMA/UTMA accounts, unlike tax-advantaged accounts like 529s.
Also, there are no restrictions on what the accounts are used for once the minor reaches the age of majority. Prior to the age of majority, withdrawals may be made for the benefit of the minor, although these expenses should be beyond basic needs and detailed record-keeping is advised for “early” withdrawals.
Tax Advantages
UGMA/UTMA accounts are technically owned by the minor and generally taxed at the child’s (lower) tax rate, although there are limits to this benefit.
In 2024, earnings up to $1,300 are tax-free, the next $1,300 are taxed at the child’s tax rate, and any additional earnings above $2,600 are taxed at the parents’ marginal tax rate.
What are the drawbacks of an UGMA/UTMA account?
UGMA/UTMA accounts are not without drawbacks, which include the irrevocable nature of contributions, tax implications, and a potential negative impact on financial aid.
Irrevocable Gift
Contributions to an UGMA/UTMA account are an irrevocable gift to the minor. Although the parent or adult controls the investment of the account until the child’s age of majority, the assets are owned by the minor.
At the age of majority, the child gains full control of the account and may use it for any purpose, regardless of the intentions of the parent or grantor.
Tax Implications (“Kiddie Tax”)
Investment earnings (dividends, interest, realized gains) of UGMA/UTMA accounts are taxable above certain income thresholds. In 2024, earnings up to $1,300 are tax-free, the next $1,300 are taxed at the child’s tax rate, and any additional earnings above $2,600 are taxed at the parents’ marginal tax rate. This is sometimes called the "Kiddie Tax."
Impact on Financial Aid
Because the minor technically owns UGMA/UTMA accounts, these accounts have an outsized impact on financial aid eligibility. While parents are expected to contribute 5.6% (at most) of their assets, students are expected to contribute up to 35% of their assets (including UGMA/UTMA assets).
How does an UGMA/UTMA account work?
UGMA/UTMA accounts may be opened at most major custodians. The parent or adult account owner maintains control of the account until the minor reaches the age of majority.
The UGMA/UTMA account may invest in investment securities (ETFs, mutual funds, stocks, etc.) or cash, just like other investment accounts (taxable accounts, IRAs, 401(k)s, etc.).
How much can you put into an UGMA/UTMA account?
There are no contribution limits to UGMA/UTMA accounts and no income limits for contributing.
However, contributions to UGMA/UTMA accounts count towards annual gift tax limits. In 2024, the annual gift tax exclusion is $18,000. Any contributions by an individual above this amount must be reported to the IRS and reduce the contributor’s estate tax exemption.
Can a parent take money out of an UGMA/UTMA account?
The rules regarding withdrawals from an UGMA/UTMA account before the minor’s age of majority are somewhat unclear. Withdrawals must be made for the direct benefit of the minor and cannot be used for routine child care expenses.
The IRS may audit withdrawals from a minor’s UGMA/UTMA account, so it’s important to keep detailed records.
Do parents pay taxes on an UGMA/UTMA account?
As of 2024, the first $1,300 of earnings from an UGMA/UTMA account is tax-free, the next $1,300 is taxed at the minor’s tax rate, and anything above $2,600 is taxed at the parents’ marginal tax rate.
A tax form (1099) will be provided by the UGMA/UTMA account custodian. If the total income is less than $1,300 in 2024, no tax reporting is required. If income exceeds $1,300, a tax filing is required, but if certain (common) conditions are met the parents may choose to report the income on their tax return instead of filing a tax return for their child.
A specific tax form (IRS Form 8814) is used to report UGMA/UTMA income.
What happens to an UGMA/UTMA account when a minor reaches the age of majority?
When an owner of an UGMA/UTMA account reaches the age of majority, they assume full control of the assets and the custodian’s role ends.
In many cases, the child may open a taxable brokerage account and transfer the UGMA/UTMA account directly into the taxable account.
What are alternatives to an UGMA/UTMA account?
UGMA/UTMA accounts are excellent flexible-use accounts to gift and save for a minor. However, they do not offer the same benefits as education savings accounts (like 529s) or maintain the same control as taxable accounts held in the parents’ names.
UGMA/UTMA vs. 529
UGMA/UTMA accounts are often cited as a potential college savings vehicle, even as a potential alternative to 529 plans. UGMA/UTMA accounts do offer more flexibility when compared to 529s, as funds may be used for any purpose once the child reaches the age of majority (including college).
However, UGMA/UTMA accounts do not offer the tax-deferred growth and tax-free withdrawals that 529 plans offer for qualified education expenses. And some states also offer a tax deduction for 529 contributions.
Overfunding a 529 plan is a common concern, but there are several options for parents with unused 529 balances. A major development in late 2023 is the ability to roll up to $35,000 from a 529 into the beneficiary’s Roth IRA.
Lastly, once the minor reaches the age of majority, the funds are out of the parents’ control and may be used for any purpose.
UGMA/UTMA vs. Taxable account
Another alternative to an UGMA/UTMA account is to invest in a taxable brokerage account owned by the parents. This preserves the flexibility in how funds are used but maintains control of the account.
However, this option misses out on the tax benefits of UGMA/UTMA accounts.
How much should I save in an UGMA/UTMA account?
UGMA/UTMA accounts are a privileged account type, falling way down the pecking order after securing retirement, education, and other household goals. It is critical for parents to prioritize their own financial future before turning to a 529 or UGMA/UTMA account.
However, UGMA/UTMA accounts may be a nice complement to your investment accounts and provide a wonderful gift to your child or loved one when they reach adulthood. Ultimately the funds could be used towards a new car, a security deposit on a first apartment, the down payment on a first home, or to help establish an emergency fund when just entering the “real world.” A balanced approach of saving in a 529 and an UGMA/UTMA is reasonable to provide flexibility in the future.
Lastly, because UGMA/UTMA accounts can be opened at most major brokerages at little to no cost, they are an excellent option for investing gifts from loved ones. Your child's UGMA/UTMA account can be opened with the sole purpose of growing cash gifts from family and friends, and you may choose to make contributions yourself at a later date.
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