UGMA and UTMA accounts

UGMA vs UTMA: Which Is Better?

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Do you want to set some money aside for your child? There are several ways to help set your child up for a strong financial future. If a 529 college savings plan isn’t ideal because you aren’t sure if your child will go to college, then you may want to look into Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA). These are two types of custodial accounts that parents and others can use to give financial gifts to minors. They are quite similar but there are a few differences that are important to know. We will discuss UGMA vs UTMA in detail to help you make an informed decision about which account to choose to set your child up for a bright future.

UGMA vs UTMA overview

The UGMA and UTMA are custodial accounts that an adult, known as the custodian, can set up for minors. The custodian and other adults can contribute to the account until the child gains full control. The account can grow quite considerably during a child’s life due to compound interest. This can help set your loved one up for their future goals.

A contribution to a custodial account is irrevocable. This means that the contribution can never be taken back as it becomes the property of the minor recipient. Once the minor reaches 18 or 21, depending on the state that you live in, the child gains full control of the account and everything associated with it. The custodian cannot tell the minor how they should spend the money. Once the minor has full ownership of the account, then they can choose to do whatever they want with the assets. For some parents, this isn’t a problem, but for others, if you want to have full control over how the money is spent, then a UGMA or UTMA may not be the best option for you.

While all of the funds belong to the minor, as his/her parent, you can withdraw money for legitimate expenses that benefit your child. Any earnings within the account such as interest are considered unearned income for the minor. This will be taxed at the child’s tax rate. 

What are the differences between a UGMA and a UTMA account?

The main difference between a UGMA vs a UTMA is the asset makeup of the account. The UGMA contains only financial products such as stocks, bonds, and mutual funds. A UTMA can have financial assets and physical assets. Some physical assets include real estate, jewelry, and fine art. You could set up a trust to leave physical assets for your loved ones but a UTMA might be a better option if you don’t want to go through the process of setting up a trust.

The second difference is related to state adoption. A UGMA and a UTMA are governed by two separate laws.  The UGMA was passed in 1956 and revised in 1966. All states have adopted the UGMA allowing parents nationwide to use these accounts.

The UTMA started 30 years later. Vermont and South Carolina do not allow UTMA accounts. The state you reside in also sets most of the terms for UGMA and UTMA accounts.

Key benefits of a UGMA and a UTMA 

  • No restrictions on money. The child can use the money for any purpose and there is no contribution limit. 
  • It can be used to teach them about money. You can involve them in the investment decisions and watch the money grow together. This can teach them about investing, the stock market, and compound interest.
  • Custodial control: Until the child reaches adulthood, the custodian has full control of the account. However, every asset within the account is owned by the minor. This will give you peace of mind knowing that the child will benefit from your contributions
UGMA vs UTMA
UGMA vs UTMA

What are the contribution rules of a UGMA and UTMA?

There are no contribution limits for UGMA or UTMA. However, whoever is contributing to the account needs to be aware of gift taxes.  The federal government requires that people pay taxes when they send someone a monetary gift. The IRS allows individuals to gift up to $15,000 to any person per year without filing a gift tax return. Even if you do give someone more than $15,000, you will likely not have to pay any taxes because the IRS allows you to gift up to $11.7 million in your lifetime before paying gift taxes. 

What are the tax implications of a UGMA or a UTMA?

UGMA and UTMA accounts are not tax-deferred assets. If the minor is under 18, or under 24 and a full-time student, the custodian can choose to report the UGMA/UTMA taxes on their income tax return. The first $1,100 of unearned income is tax-free. The next $1,100 in earnings is taxed at the kiddie tax rate which is 10%. If the unearned income is more than $2,200 per year then the earnings are subject to the parent’s tax rate. It’s best to talk to a financial advisor or tax specialist to make sure you are aware of any taxes that you may incur.

529 vs UGMA vs UTMA
529 plans vs UTMA and UGMA

529 plans vs UTMA and UGMA 

The 529 plan is a college savings account that many people use to save for their children’s college education.  People who set up UTMAs or UGMAs are likely to have goals other than paying for their child’s college education. 

One key difference between custodial accounts and 529 plans is that custodial accounts can be used for non-educational purposes, whereas 529 plans can only be used to cover qualified education expenses. Only cash contributions are allowed for 529 plans. 

Another difference is that the custodial accounts are the child’s assets and the 529 plan is the parents’ asset. A 529 could potentially be redirected to another child while the custodial account could not. Custodial accounts give the child more freedom over what they want to do with the money. 

UGMA and UTMA accounts are counted towards financial aid. The Free Application for Financial Student Aid (FAFSA) looks at both the child’s income and the parent’s income to determine eligibility for financial aid. FAFSA considers UGMA and UTMA your child’s assets so they will count the assets at a rate of 20% compared to 5.64% which is the parental rate. They consider a 529 plan as assets of the parents. This means that if you have a UGMA or a UTMA then you will receive less financial aid. If your own income/net worth is enough to make your child ineligible for FAFSA then this information may be obsolete to you.

UGMA and UTMA always incur taxes in the year that you have earnings. However, if the money from your 529 plan is used for college or educational purposes, then you will incur no tax liability even on earnings.

If your primary goal is to invest money for educational purposes, then a 529 plan might be the best option for you. However, if you want to gift money for purposes other than education, then a UGMA or UTMA might be a better option for you. You can also move money from an existing custodial account into a 529 college savings plan.

If you would like to contribute to your loved ones’ future, a UGMA or a UTMA may be a good option. While UGMA and UTMA are similar, there are key differences to consider. This comes down to the type of asset that they hold and state adoption. Whether you decide to set up a UGMA, UTMA, 529, or another savings account, it really comes down to goals. Talk to a financial advisor to help you decide which option may be best for you and your family.

Best Financial Planner Washington DC

Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.

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District Capital is an independent, fee-only financial planning firm. We help professionals and entrepreneurs in their 30s and 40s elevate their finances and maximize their money. We are based in Washington, D.C and we work with people virtually nationwide.

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