UTMA and UGMA accounts: An overview

UTMA and UGMA accounts: Background and overview

Securing your child’s financial future is a top priority for parents. But gifting property directly to a child can be complicated. Minors can’t legally hold stocks, mutual funds, or many other types of assets in their own name. While formal trusts and guardianships can solve this issue, they can be costly and complicated to set up and maintain. To make the process simpler, special custodial accounts were created. UTMA and UGMA accounts allow an adult, or a designated custodian, to manage the assets on behalf of a child until they reach the age of majority.

What is an UGMA account?

An UGMA account is a custodial account created by the Uniform Gift to Minors Act. This law was passed in 1956 and adopted by all 50 states. It allows parents or other adults to give cash and financial securities such as stocks and bonds to minors without the need for a formal trust or guardianship.

What is an UTMA account?

An UTMA account is a custodial account created by the Uniform Transfers to Minors Act. The law was passed in 1986 to expand on the UGMA by broadening the range of assets that could be transferred to a minor. UTMAs can include real estate and other physical property in addition to the financial properties covered by an UGMA.

UTMA vs. UGMA accounts: The key difference

The main difference between UTMA and UGMA accounts is the type of assets these accounts can contain.

Types of property that can be included in UGMAs:

• Cash
• Stocks
• Mutual funds
• Exchange-traded funds (ETFs)
• Bonds
• Life insurance policies

Types of property that can be included in UTMAs:

• Real estate
• Fine art
• Collectibles
• Patents
• Royalties
• Legal settlements

Because UTMAs can contain physical property, they may be a good choice when planning for long-term investing where the beneficiary can take over the property at the age of majority and continue to hold the assets. With the cash and financial securities that make up an UGMA, this type of account makes it easier for the beneficiary to access the assets in the form of cash when they take control of the account.

UTMA and UGMA account benefits

UTMA and UGMA accounts provide several benefits:

• The funds and assets can be used in any way the beneficiary chooses.
• No annual contribution limits apply.
• Custodial accounts can be less expensive to set up and easier to manage than a trust or guardianship.

UTMA vs. UGMA account rules

Several rules govern the way UTMA and UGMA accounts operate. Some of these rules include:

• The transfer of assets into a custodial account is irrevocable, meaning once given, they can’t be taken back.
• The assets in the account cannot be withdrawn or sold unless done for the direct benefit of the child.
• Because the account belongs to the child, they are responsible for paying taxes on any income produced by the account (more to come on taxes).

UTMAs and UGMAs vs. educational savings accounts

Like 529 college savings plans and Coverdell education savings accounts, UTMA and UGMA custodial accounts can be used to save for education. However, several factors set custodial accounts apart from college savings plans:

• Permitted uses: The funds in a 529 or Coverdell account are for qualified educational expenses. If used for unqualified expenses, a 10% federal penalty may be applied. The use of UTMA and UGMA custodial accounts is not limited.  
• Taxability: The primary benefit of 529 and Coverdell accounts is that they are tax-advantaged. The accounts grow tax-deferred, and funds are not taxed so long as they are used for qualified educational expenses. The minor who owns the custodial account is responsible for paying taxes on the earnings.
• Control: Since UTMA and UGMA accounts can be used for any purpose, once the assets are turned over to the beneficiary, they can spend the funds in any way they choose.
• Contribution limits: UTMAs and UGMAs are not subject to annual contribution limits. However, 529s have aggregate contribution limits (overall total limit). Coverdell accounts have annual contribution limits, and eligibility to participate in the program may be restricted by income.
• Revocability: UTMA and UGMA accounts are irrevocable—the beneficiary cannot be changed, and the assets cannot be taken back by the grantor. On the other hand, 529 and Coverdell accounts can be transferred if the original beneficiary no longer needs the funds.
• College financing: UTMAs and UGMAs may lower the child’s eligibility for certain types of financial aid. Because custodial accounts are owned by the minor, they are considered part of their net worth when filling out the Federal Student Aid (FAFSA) form. While 529 and Coverdell accounts may also decrease eligibility, the impact is not as great because those accounts are considered the property of the parent or guardian.

Custodial accounts and college savings plans can be smart ways to provide for a child’s future. An understanding of their tax implications is essential to making the right choice for your child and receiving the full benefits of these accounts.  

UTMA and UGMA tax filing requirements 

Generally, the transfer of assets to a custodial account is not taxable. However, if the annual gift tax limit is exceeded, then you’ll have to file a gift tax return in addition to your federal tax return the next year. While the gift may not be taxable, the earnings carry tax implications for the beneficiary.

The earnings of UTMA and UGMA accounts are taxable to the child and they must file under their own Social Security number. However, several tax advantages may apply. For example, a portion of the account’s earnings may be exempt from federal income tax, and as a minor, the beneficiary will pay the kiddie tax rate on the taxable portion. The kiddie tax rate is lower than regular tax rates, though it comes with limits to prevent families from avoiding taxes by giving large portions of their assets to their children. Once the kiddie tax limits have been exceeded, the parent’s or guardian’s tax rate will apply.

Related: What is inheritance and is it taxable?

How to open an UTMA or UGMA account

UTMA and UGMA accounts can be opened at many financial institutions such as banks and brokerage companies. Here are some steps you’ll need to take:

1. Choose a financial institution: As with any investment, it’s important to find a company with a strong financial history.
2. Provide required information: To apply for a custodial account, you’ll need to provide your name, address, and Social Security number as well as those of the beneficiary.
3. Name a custodian: You will also need to name a custodian who will oversee the investment until the beneficiary is given control of the account at the age of majority. You can serve as the custodian, or you can name someone else. Either way, it’s also a good idea to name a successor custodian in the event that the original custodian becomes unable to fulfill their obligation.
4. Fund the account: Once the account is opened, you’ll need to fund it with a cash deposit that will be used to purchase the securities that will make up the account. If you are setting up an UTMA for physical assets, you will transfer the title of the assets to the account. It’s important to note that once a custodial account is created, the assets belong to the child. The irrevocable nature of the account means you cannot get them back and they can only be used for the direct benefit of the minor.

UTMA and UGMA accounts offer a simple way to give financial gifts and property to a child without a trust or formal guardianship. While both allow an adult to manage assets on behalf of their child, UTMAs can hold a wider range of property than UGMAs. Understanding how these accounts work can help you plan smarter, more flexible financial gifts for your child.

UTMA and UGMA FAQs

RELATED CONTENT

*Neither New York Life nor its Agents provide personalized legal or tax advice. Please contact your legal or tax adviser to find out more about UGMA or UTMA accounts.