Diapers to Diplomas
Melissa Fernalld, CFP®
Strategic’s Senior Advisor, Melissa Fernalld, breaks down the good, the bad and the ugly of using UGMA or UTMA custodial accounts to invest and save for your children.
What are Custodial Accounts?
The most common custodial accounts were formed under the Uniform Gift to Minor’s Act (UGMA) and Uniform Transfer to Minor’s Act (UTMA) which created accounts where a custodian (parent or other adult) holds and protects assets for a minor child until they reach the age of majority in their state (21 in New York). UTMA is the successor to the UGMA and most common in almost all states.
The Good:
UGMA and UTMA accounts provide an easy way to gift/transfer assets to a minor’s name. While UGMA and UTMA accounts can be used for education, this is not their sole purpose. They can be used for pre-college education and expenses or, once the minor reaches age of majority the funds can be used for anything.
These accounts allow for greater investment options than 529 college savings accounts and just about any type of security can be gifted/transferred to an UTMA and UGMA. UTMA law even allows for real estate to be transferred into the accounts.
UGMA/UTMA accounts can also provide a tax benefit for the custodian with the first $1,250 of interest, dividends, and capital gains exempt from taxes and the second $1,250 taxed at the child’s rate.
*Tax year 2023 values, subject to change each year.
The Bad:
The same tax benefit listed above can also make custodial accounts unattractive in that unearned income over $2,500 is fully taxed at the custodian’s tax rate for children under age 19 and full-time students under the age of 24.
Custodial accounts have a high impact on financial aid eligibility. UGMA/UTMA accounts are treated as an asset of the student on a FAFSA form and will reduce their financial aid eligibility by 20% of the value (versus 5.64% of a 529 which is listed as a parent’s assets).
*Tax year 2023 values, subject to change each year.
The Ugly:
Once assets are put into a UGMA/UTMA account they are owned by the child. That’s right, the assets no longer belong to the parent even though they are the custodian. If capital needs arise down the road, the custodian cannot use them for themselves, and may suffer from “UGMA/UTMA regret”.
When the child reaches age of majority they gain full control of the assets and can spend it on whatever they want. While this may be perfectly suitable for some young adults, it may be too soon for others to gain control of what could be significant financial assets.
Our Thoughts
If you specifically want your gift to be used towards the child’s college education, we recommend a 529 college savings plan. This will ensure your intention and provides greater tax benefits. If you desire flexibility and want your child to gain a greater sense of financial responsibility in life, a UGMA or UTMA account may be the right solution for you.
About Strategic
Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets of over $2 billion.
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