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When you have children in your life, you want them to be cared for and financially secure.
The Uniform Transfers to Minors Act (UTMA) established UTMA accounts as investment accounts that parents or guardians can open on behalf of a minor to give them some financial security.
Though it’s a popular investment option, a UTMA is not the best choice for every family. Understanding the advantages, drawbacks and tax implications can help you make an informed decision about what’s best for you and your family.
Uniform Transfers to Minors Act Definition
The UTMA created an opportunity for adults to create a different type of trust for minors. The unique trusts, known as UTMA accounts, allow parents, grandparents and guardians to transfer property and money for the minor to access when they reach adulthood.
By setting up a UTMA account, adults can provide financial stability and assurance to minors who can’t manage the funds yet. It’s an ideal way of creating a viable savings and investment opportunity for minors.
How a UTMA Account Works
The parent, grandparent or guardian establishes the UTMA account on behalf of the minor. They may serve as the custodian for the account until the minor attains the age of adulthood as set forth by their state.
These accounts allow the custodians to make monetary contributions and investments on the minor’s behalf. While the minor owns the fund, since it’s established as a gift, the fund can accumulate earnings without the custodian paying taxes on them.
Of note, anybody can make contributions to the UTMA fund in nearly any form, including stocks, bonds, and mutual funds. However, the guardians cannot transfer funds out of the UTMA account without previous authorization or a court order.
Examples of UTMA Accounts
UTMA accounts sound complicated, and there are some distinct qualities to understand before committing to one. However, there are some excellent examples of UTMA accounts working well for minors.
Vanguard UTMA Accounts
Vanguard offers UTMA accounts as savings opportunities for families. Parents can make investments on behalf of their child to ultimately cover the cost of college.
Unlike similar options, the minor won’t be penalized if they don’t use the funds to pay for college.
Fidelity Custodial Accounts
Fidelity notes the tax benefits of opening an UTMA account for investing and to transfer funds to a minor for future use. However, the firm also remains transparent about the custodial account counting against a minor when considering their financial aid eligibility.
UTMA Account Rules
The UTMA established the regulations and restrictions for UTMA accounts.
- Minors cannot access the funds until they reach age 18 or 21, depending on the age of maturity in their home state.
- Several restrictions prohibit using the funds for certain things before the minor comes of age. The rules exist to protect the fund’s stability.
- One key restriction prevents anyone from withdrawing funds or using them as collateral.
Finally, to protect the minor’s interests, the account cannot change to another beneficiary unless they agree or the parties involved obtain a court order.
There are many reasons for adults to consider opening a UTMA account for minors in their lives. Aside from creating financial security, it’s the first step for a minor to learn about investing.
Easy to Open and maintain – UTMA accounts require limited paperwork that’s easy and quick to complete, provided you have the requisite information for the minor. It’s also important to understand the rules and limitations and find a reputable brokerage firm or financial institution to handle the account.
It’s extremely easy to track transactions and follow the savings account growth and asset values.
Access to a wide range of assets – Though assets can vary by broker, most UTMA accounts provide access to several asset types. Plus, these custodial accounts let the guardian select the investments they find most appealing, including cryptocurrency, exchange-traded funds and real estate.
UTMA accounts provide more growth opportunities than a traditional savings account while teaching the minor about investing and financial responsibility.
Can Gift up to $17,000 without tax penalties – Generally, when you send a large sum of money to another person, the Internal Revenue Service requires a gift tax on those funds.
With a UTMA account, you can contribute up to $17,000 in a year without incurring penalties or a gift tax. Note that the limit can vary from year to year, so it’s important to keep up with the most recent data.
Portion of funds are taxed at the child’s tax rate – Aside from the gift tax benefit, assets in the UTMA account get taxed at the child’s tax rate instead of counting against the custodian’s.
This provision allows parents to contribute more money without fear of the minor incurring excessive taxes on the funds.
Beneficiary can use funds for anything – Perhaps the most appealing aspect of UTMA accounts is the flexibility. The beneficiary can use the funds for anything they want, including a down payment on a house or buying a new car.
Despite the obvious appeal of UTMA accounts, there are some limitations to consider before opening one for your minor.
Cannot change beneficiary – Once you establish UTMA accounts, you cannot change the beneficiary for any reason. Those funds belong to the minor from the moment the first funds clear the account.
529 plans offer better tax benefits – Despite the gift tax options, UTMA accounts don’t offer as many tax benefits as 529 plans in terms of saving for educational expenses.
UTMA account withdrawals are taxable at the account owner’s income tax rate. A 529 plan solely supports educational costs. These accounts come with tax-free withdrawals as long as they are spent on qualified educational expenses, such as tuition and textbooks.
Affect ability for child to receive financial aid – Speaking of education, having a UTMA account can impact your child’s eligibility for need-based financial aid. They must include the assets on their free application for federal student aid.
UTMA vs. UGMA
UTMA accounts come from the Uniform Transfers to Minors Act and can be easily confused with UGMA accounts, which stem from the Uniform Gift to Minors Act. Though they have some similarities, there are several distinct differences between the two types of accounts.
Both accounts allow guardians to transfer assets to their minors without establishing a legal trust. The key difference between the two accounts comes down to what assets you can transfer into them.
With a UTMA account, you can transfer anything, including real estate. UGMA accounts only permit you to contribute securities, such as stocks and mutual funds.
UGMA and UTMA accounts both have tax implications for the minor, although the “kiddie tax” rate that the accounts are subjected to is lower than the adult level.
However, once the beneficiary reaches adulthood and takes control of the assets, they fall under the standard income tax rates.
How to Open a UTMA Account
As noted, UTMA accounts are easy and painless to establish, but that doesn’t mean you shouldn’t take your time through the process.
- Research a brokerage firm.
- Set up an UTMA account for your child.
- Provide important details like the child’s name, birthday, social security number, and beneficiary.
- Fund the account.
- Start researching investments.
Are UTMA Accounts a Good Idea?
UTMA accounts can help you establish financial security for your child’s future by providing a sound foundation. The minor can spend the money on anything they choose, including a house, car, or college.
While these accounts come with some valuable tax benefits, your child will ultimately have to pay income tax on the assets. Plus, the UTMA account could have an impact on financial aid, making it less desirable than a 529 plan.
What happens to a UTMA account when the child turns 18?
When a child attains age 18 (or 21 according to some state laws), they gain control of the UTMA funds. The beneficiary can use the funds as they see fit.
Can I withdraw money from a UTMA account?
UTMA account custodians can manage the assets, which includes withdrawing funds for the minor’s use. However, you cannot return funds after withdrawing them, which may involve paying taxes and penalties.
Can a minor receive gifts or assets without a guardian or trustee?
Yes, a minor can receive gifts or assets without a guardian or trustee. The UGMA and UTMA permit asset transfers without establishing a trust or estate.
When can a child claim ownership of a UTMA account?
A child can claim ownership of a UTMA account when they reach adulthood. The exact age depends on the individual’s state laws, though typically it is either age 18 or age 21.