UGMA and UTMA accounts are types of custodial accounts that work as college savings options.
UGMA stands for Uniform Gift to Minors Act and UTMA stands for Uniform Transfer to Minors Act accounts. Both are similar in many ways but there are a few significant differences between the two.
What Are UTMA And UGMA Accounts?
UGMA or Uniform Gifts to Minors Act was the first to be established. This law allows minors to receive specific types of gifts without needing a guardian or trustee to oversee the account. Gifts that can be received under UGMA are limited to financial assets such as cash, bonds, stocks, and insurance products.
UTMA or Uniform Transfer to Minors Act extends the original scope of the UGMA. Under UTMA, in addition to the original list of financial assets, minors can also receive tangible gifts in the form of real estate, works of art, royalties, and patents.
Another difference between UGMA and UTMA is the time at which each account matures. Under the UGMA, the minor can access the assets in their account when they reach 18 years of age. The UTMA provides additional time for the gifted assets such as bonds to reach their maturity dates. By contrast, the UGMA requires the assets to be assumed by the minor once the minor reaches 18 years of age.
The gift-giver or donor may take on the responsibility of managing the minor’s account until the latter comes of age. Alternatively, they may appoint a custodian to manage the account until the minor is of legal age.
These two Acts shield minors from tax consequences on the gifts, up to a specified value. The tax generated from the UGMA/UTMA accounts are not completely tax-sheltered. Instead, they are taxed at lower rate known as a kiddie tax rate. This applies only up to a certain amount.
The exact legalities may vary among individual states. Some states adopt the UTMA as is for their residents, while others may amend one or more clauses.
How UGMA / UTMA Accounts Work
In most states, it is illegal for minors to contract. This prevents them from owning any type of mutual funds, life insurance policies, annuities, stocks, or bonds. In addition, parents are not allowed to directly transfer assets to their minor children. The only way for parents to transfer assets to a minor child is through a trust. The most common trust for a minor in the USA is an UGMA or UTMA account.
The UGMA/UGMA account functions as a type of custodial account. The account can be opened through a bank or brokerage institution. Family and friends can contribute to the account. These deposits are irreversible. All deposits into the account become permanent transfers to the minor. There are no income limits or contribution limits.
Assets in these accounts are generally used to fund the beneficiary’s education. However, the custodian can make withdrawals and use the funds for any purpose that directly benefits the account holder. The funds can also be used to purchase publicly-traded financial assets such as mutual funds, stocks, or bonds on behalf of the minor. There are no penalties for withdrawing funds from an UGMA/UTMA account provided that it is used for permissible purchases.
On reaching the legal age of maturity in that state, the minor is granted full access to their account. They can then use the funds as they wish without requiring permission of the donor or custodian. After the minor becomes an adult, neither the donor nor the custodian can impose any restrictions on how the money can be used.
Benefits of UTMA/UGMA
The biggest benefits of UGMA/UTMA are the tax implications. Funds contributed into these accounts are exempt from paying a gift tax up to a specific amount per year. This may change from one year to the next. In 2021, cash of up to $15,000 per year was exempt from gift tax.
If the funds contributed into the account earn income, the first $1,050 is tax-free. Any income earned above $1,050 is taxed at the ‘kiddie rate’. Kiddie rate refers to the tax rate of the minor who is the account holder. Since the minor account holder’s income is considerably lower than that of the adult donor, this results in substantial tax savings. Moreover, if this is the only income that a dependent child has, the child does not even need to file a return.
Impact of UGMA/UTMA on Federal Financial Aid Eligibility
Custodial accounts are considered the account-holder’s asset, in this case, the minor child. The funds are counted as the child’s income when applying for financial aid towards college tuition. This may reduce the amount of financial aid that the minor would have otherwise received. It may also make them ineligible for a number of initiatives such as need-based college scholarship programs. In some cases, it may make them ineligible for any type of financial aid at all. This is one of the major downsides of having an UGMA/UTMA account.
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