We parents would all like to provide our children with the best possible financial head start in life. Educating them on how to save, invest, and make smart money choices can position them for long-term success. One of the ways to begin saving wealth for your child is a UGMA custodial account.
UGMA accounts allow parents, grandparents, and other relatives to invest on a child’s behalf, ensuring a solid financial future.
What Is a UGMA Account?
UGMA is the Uniform Gifts to Minors Act, which is an account that is custodial in nature and will allow an adult to invest on the minor’s behalf. Minor children are prohibited by law from holding stocks, bonds, and mutual funds, so a UGMA account will hold them in such items as these once they become of age.
Unlike the usual trust that involves a written instrument and a trustee, the UGMA account is easily accessible and conforms to terms provided by specific states.
UGMA vs. UTMA: What’s the Difference?
UGMA accounts are also characterized as being very much like UTMA (Uniform Transfers to Minors Act) accounts, but they have differences. While both allow adults to manage money for minors, a UGMA account will only hold securities like stock, bonds, and mutual funds. UTMA accounts, however, are allowed to hold real property, art, and other things of property.
One consideration is that UGMA accounts can be had in every state, but UTMAs are prohibited in South Carolina. In choosing between the two, consider what types of property you wish to transfer and the specific laws of your state.
How to Open a UGMA Account
UGMA accounts are available through banks, brokerage firms, and financial institutions. Before choosing a provider, consider the following:
- Investment Options: Some firms offer a wider range of investment choices.
- Fees: Compare account maintenance fees and trading costs.
- Age of Majority: Check your state’s laws on when the child will gain control over the account.
You can open a UGMA account through a variety of platforms, including major brokerages like Fidelity and Charles Schwab.
Who Owns the Assets in a UGMA Account?
The legal title to the property in a UGMA account vests in the child, although the minor cannot handle the account. Contributions are non-withdrawable, i.e., property or cash, and the same, having been deposited into the account, cannot be withdrawn.
The trustee, who is usually a parent or guardian, is in a fiduciary relationship and has to act in the best interest of the child, investing the money until the child attains the age of majority (18 or 21 years in most states). The money then belongs to the child, and he/she can use it as he/she wishes.
Tax Implications of UGMA Accounts
UGMA accounts lack the tax benefit of 529 higher education savings plans but share some benefits:
- Contributions are made in dollars after taxes.
- The initial $1,150 of unearned income in 2022 is tax-free.
- The remaining $1,150 is taxed on the tax rate of the child (which will likely be lower than the parent’s).
Over $2,300 of income is taxed at the parent’s rate (a provision designed to discourage parents from treating UGMA accounts as tax shelters).
For additional information on tax rules for UGMA accounts, visit the IRS Website.
How UGMA Accounts Affect College Financial Aid
Planning for college? Keep in mind that UGMA accounts impact financial aid eligibility more than parent-owned accounts like 529 plans.
- Student-owned assets (like UGMA accounts) are assessed at 20% for FAFSA calculations.
- Parent-owned assets (like 529 plans) are assessed at only 5.64%.
This means that a UGMA account may reduce the amount of need-based financial aid your child qualifies for. If college savings is your primary goal, consider how a UGMA stacks up against a 529 college savings plan.
Pros and Cons of UGMA Accounts
Pros:
- Flexibility: Over 529 plans since the funds can be used for any purpose and not just for education.
- Easy to Set Up: No paperwork and court approval is required.
- Investment Opportunities: Gives the children an early head start through stocks, bonds, and mutual funds.
- Learning Tool: Facilitates teaching children about investing and managing money.
Cons:
- Effect on Financial Aid: The UGMA funds will be considered assets for the student and decrease their eligibility for financial aid.
- Irrevocable Contributions: The contributions of money are owned by the child and cannot be withdrawn by the parent.
- No Tax-Free Growth: In contrast to a 529 plan, investment earnings on a UGMA account can be taxed.
Final Thoughts
A custodial UGMA account is an excellent way to save your child’s financial future. Though it is not as tax-preferred as a 529 plan, it is a versatile choice that makes it a parent’s first choice for saving for reasons other than college. If your child goes to college, buys a starter house, or starts a business, a UGMA account can give them a financial jump-start toward self-sufficiency.