Is An UGMA or UTMA Custodial Account Right for My Child?
While 529 plans are quite well known, many people are not familiar with the other widely used option for giving money to children or grandchildren: a custodial account. There are two types of custodial accounts, known by their acronyms UGMA and UTMA.
- An UTMA, or Uniform Transfers to Minors Act account, is a type of custodial account established to hold and manage assets for a minor until they reach a specified age.
- An UGMA, or Uniform Gifts to Minors Act account, is a custodian account that allows adults to make gifts of assets to minor.
Unlike a 529 plan these accounts are not designed specifically as vehicles to pay for higher education. They also differ from irrevocable trusts which are a standard way of transferring substantial wealth to family members but require lawyers to write customized documents, incurring significant expenses and, often take months to complete. UGMAs and UTMAs have the advantage of great simplicity and cost virtually nothing to create. You can open one online at most major brokerages such as Schwab, Fidelity and Vanguard within half an hour. Then you have full range of standard investment choices such as mutual funds and ETFs.
UMGA vs. UTMA
To decide which is better suited to your needs you should consult an attorney about the laws that apply in your state. In Illinois, UTMAs are by far more commonly employed than UGMAs. UTMAs generally can hold a broader array of assets than UGMAs such as private real estate.
Funding UGMAs & UTMAs
In 2024 IRS rules allow individuals to gift up to $18,000 to another person without incurring any taxes. It makes sense to schedule regular contributions to custodial accounts over a number of years to stay under this limit. The account creator initially retains control over the deposited funds but they can be used solely for the benefit of the minor. When the beneficiary reaches a defined age, varying by state, but typically between 18 and 25, he or she can then invest the money or disburse as they see fit. At that point they can also close the account.
Tax
There are some small tax advantages to custodial accounts. Federal rules exempt certain low levels of custodial income from taxes, slightly over $1,000 level, and then apply child’s likely low tax rate to next roughly $1,000, before the owner’s tax rate is applied. An S&P 500 equity index fund with a 2% dividend yield, for example, is thus unlikely to incur significant taxes until the account reaches over $100,000 in value. Please check with specific state and federal sources and your accountant for tax and other rules which govern the precise vehicle you plan to employ.
Additional Considerations
- Assets held within custodial accounts may count against a student in determining college financial aid awards.
- Unlike a 529 plan, the beneficiary of a custodial account can never be changed.
- 529s plans allow for much larger tax free contributions than custodial accounts in the initial years after opening.
- Earnings in 529s typically never incur taxes while custodial accounts over low value thresholds require tax payments at parent’s income tax rate every year.
- 529 accounts hold only liquid securities while UTMAs frequently are allowed to hold less liquid assets.
Written By David L. Frank, CFA
The information provided in this article is for informational purposes only and does not constitute financial advice. While the insights and opinions expressed are based on professional experience and current market knowledge, they are not a guarantee of future performance. Readers should consult with a qualified financial advisor to discuss their specific investment needs and objectives before making any investment decisions. The information contained in this article has not been filed with, reviewed by or approved by the SEC or any other United States regulatory or self-regulatory authority.