Minors typically can’t own assets in their name; however, states have adopted laws that allow a custodian to hold assets for a minor until they become an adult (usually 18 or 21, depending on where you live).
Laura answers a listener’s question about investing for a young child and reviews the pros and cons of UGMA and UTMA accounts for minors.
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I received an email from Asher S., who said, “I've been enjoying your podcast for several years. Even when the topics aren't directly relevant to my situation, it's always good to see what I can apply from your advice. I have two questions about the UTMA I set up for my one-year-old daughter. First, when (if ever) can a parent withdraw funds from a UTMA? And, second, where can I invest those funds so she gets better returns than from a savings account?”
Thanks so much for being a long-time listener and sending in your questions, Asher! I’ll answer them and explain what families should know about UTMA and UGMA accounts for minors. So, if you’re a parent or plan to start a family someday, don’t miss this show.
Hi, everyone! I’m Laura Adams, a personal finance expert who’s been hosting the Money Girl Podcast since 2008, with over 40 million downloads. I’m also the author of several books, including my most recent title, which was a No. 1 Amazon New Release, called Money-Smart Solopreneur–A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. If you’re building a business or want to earn more income, I hope you’ll grab a copy of the paperback, ebook, or audiobook today!
If you’re enjoying the show or have a money question or topic suggestion, you can leave a message 24/7 at 302-364-0308. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.
Minors typically can’t own assets in their name; however, states have adopted laws that allow a custodian to hold assets for a minor until they become an adult (usually 18 or 21, depending on where you live). Parents can transfer assets to children without creating a formal trust using these special custodial accounts.
UTMA accounts get their name from the Uniform Transfers to Minors Act. And UGMA stands for the Uniform Gifts to Minors Act. A UGMA only allows financial assets, like stocks and mutual funds, to be held for a minor beneficiary and is available nationwide.
A UTMA allows financial and physical assets (like real estate, precious metals, and fine art) and is available in every state except South Carolina. Plus, it may allow you to maintain custodianship until the beneficiary reaches age 25, depending on where you live.
Any adult resident of the U.S. can open and contribute to a UGMA or UTMA for a minor. The custodian named on the account and the person making the gift or transfer can be the same or different people. The custodian manages the funds, investments, or other assets, but the minor legally owns them.
Asher asked when a parent can withdraw funds from a UTMA. The funds can only get spent directly to benefit the child, such as healthcare or education. But you can't withdraw funds that help you or use the money for things you're legally obligated to pay, such as housing and food for the minor child.
Also, note that assets in a UTMA or UGMA account are irrevocable. In other words, you can't take them back once you transfer them to the beneficiary minor and become their property. A UTMA or UGMA custodian has a fiduciary duty to manage the account assets for the minor's best interests until the child reaches the age of majority.
Since the beneficiary minor owns UTMA and UGMA assets, the account gets reported to the IRS under the child's Social Security number. Therefore, with help from their parent or the account custodian, the minor must report the income and pay income taxes due on any investment earnings in the account.
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Now that we’ve covered an overview of UTMA and UGMA accounts, let's review five ways you benefit from using one to save and invest for a child.
1. Investing in many asset types.
Asher asked where to invest his daughter’s UTMA funds to get higher returns than he can get from a savings account. You can choose a wide range of assets, particularly with UTMA accounts. As I mentioned, they allow you to transfer financial and physical assets for a minor.
That means a UTMA can include everything from CDs, stocks, bonds, options, mutual funds, exchange-traded funds, real estate, vehicles, collectibles, precious metals, intellectual property, life insurance, and annuities.
UTMA and UGMA accounts get set up by brokerage firms and banks. However, your investment options get limited by the financial institution or brokerage you choose, such as Vanguard or ETRADE.
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2. Having custodial control.
Until a UTMA or UGMA beneficiary reaches adulthood, the custodian or parent has full control of the account. The custodian makes investment decisions and determines any special circumstances where the money may get withdrawn for the minor’s benefit.
However, every asset within the account is owned by the minor. That can give you peace of mind that a child will benefit from your contributions once they become an adult.
3. Not being subject to annual contribution limits.
A primary benefit of using a UTMA or UGMA account is giving a child as much money or assets as you like because there are no annual limits on the dollar amount of gifts or transfers you can make. However, amounts over $17,000 given by an individual or $34,000 for a married couple filing joint taxes are subject to the federal gift tax.
However, most Americans avoid paying the gift tax due to the lifetime gift tax exclusion, a credit of up to $12.92 million for 2023. That means you can give gifts valued at up to $12.9 million over your lifetime without owing any gift tax. So, unless you're pretty wealthy, it will not affect you.
4. Having funds for any purpose.
Unlike a college savings plan, a UTMA or UGMA beneficiary can use the funds or assets for any purpose. Once the minor reaches adulthood, they own the account assets and can spend them any way they like, such as for education, travel, or a down payment on a home.
As I mentioned, a UTMA or UGMA custodian can only withdraw funds for purposes that directly benefit the beneficiary.
5. Getting tax efficiency.
Since the minor beneficiary of a UTMA or UGMA owns it, income generated in the account typically gets taxed at the “kiddie tax rate” instead of the parent’s tax rate, which can reduce taxes.
The first $1,250 of a minor’s income is tax-free, and the next $1,250 gets taxed at the child’s tax rate. Any income above $2,500 gets taxed at the parent’s tax rate.
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Now that we’ve covered the pros, let's review five potential downsides of UTMA and UGMA custodial accounts.
1.. Making irrevocable contributions.
The minor beneficiary always owns UTMA and UGMA accounts. Therefore, transfers of assets or gifts put in one can't be revoked, nor can the account be closed.
Once the minor reaches adulthood, the custodian must turn over all the account assets to them, and they can manage the account any way they wish. If the child dies, the assets are typically payable to the child's estate unless you designate another beneficiary.
2. Getting no tax benefits.
Unlike a 529 savings plan or retirement account, contributions and earnings in UTMA and UGMA accounts offer no tax benefits. Earnings are subject to federal and applicable state income taxes and must get reported under the minor beneficiary’s Social Security number.
3. Affecting federal financial aid.
Since the minor beneficiary of a UTMA and UGMA owns the account assets, they get reported on the Free Application for Federal Student Aid or FAFSA. Unlike a 529 savings plan, custodial accounts are a more significant factor in the calculation for need-based financial aid because the child owns them. The FAFSA counts a student's assets at a rate of 20% compared to 5.64% for parents.
In other words, having a UTMA or UGMA with substantial assets means your family could receive less financial aid for college. However, if you have a high income or net worth, your child would likely be ineligible for student aid, making this con unimportant for you.
4. Having no future financial control.
Another downside of UTMA and UGMA accounts is that once the beneficiary reaches the age of majority, parents have no say over how they spend the money or use the assets. You must give them control and don't get to decide how they spend the money.
5. Paying income taxes.
I mentioned that income generated by the assets in a UTMA or UGMA is not tax-deferred and gets subject to the “kiddie tax” over a certain threshold.
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Asher, I hope this clarifies the UTMA rules for you. I’m impressed that you’re already setting money aside for your infant daughter. A question I often receive from parents is when they should start investing for a child. While saving sooner is always better than later, there’s no right or wrong answer because it depends on your financial situation and goals.
Every parent wants the best for their kids, but it’s also critical to make wise decisions for your own financial future. If you don’t have an emergency fund or haven’t started saving for retirement, that’s where you should start. If you jeopardize your financial future, you may have to rely on your kids to support you in your old age!
While it might seem coldhearted for a parent not to save or invest for a child, don't forget that kids typically have options, like working, getting college scholarships, and federal student loans. But there are no loans or grants to support you in retirement outside of Social Security retirement benefits or a workplace pension you may be eligible for.
If you're a good saver, you could end up with a surplus and help a child pay their student loans or leave them an inheritance. The bottom line is that you must make wise decisions for your financial future. So, only set aside money for your kids if you can genuinely afford it.
Ideally, you should regularly save at least 10% to 15% of your gross income for retirement before saving for your kids. And if you're less than 20 years from retirement and haven't reached 80% of your savings goal, I want to encourage you to stay exclusively focused on building your retirement nest egg.
That's all for now. I'll talk to you next week. Until then, here’s to living a richer life.