UGMA vs UTMA: Which is the Best for College Savings?

Many parents may want to get an early start on securing their child’s educational and financial future. The Uniform Gift to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) are both excellent options to consider. These accounts are very flexible and beneficial for your child’s future. You can choose the types of investments and decide when your child receives these funds. 

UGMA vs UTMA: Overview

UGMA and UTMA accounts are both custodial accounts that allow a person to set aside funds for their children to receive in the future. These funds are effectively like a trust that your child can receive when they are an adult. You can invest the funds in stocks, bonds and other assets.

When your child is 18 years or older, they can access these funds. Unlike 529 plans, your child can use these funds for any type of expenses, not just education expenses.

Uniform Gifts to Minors Act (UGMA) 

UGMAs have been around since 1956. This account allows parents to invest in assets like stocks, bonds and mutual funds. UGMAs are essentially a trust alternative for less wealthy families who still want to help their children prepare for the future. This account is an excellent option for parents who want to give their children money for future expenses.

This account also has less flexibility, as the UGMA automatically transfers the assets to your child when they become a legal adult. However, the age of majority is higher in certain states like Alabama, Nebraska, New York, Indiana, and Mississippi. Your child may be unable to access the funds until they turn 19-21 if you live in these states.

Uniform Transfers to Minors Act (UTMA)

Several decades later, parents soon become eligible to open a UTMA, which has many benefits in terms of flexibility. New legislation was created in the 1980s, after some states saw the limitations of UGMAs. UTMAs were created in 1996 to allow more flexibility for parents who were interested in different types of investments.

UTMA accounts also offer parents more control in when their child receives funds. Based on current regulations, parents may choose when their child receives the funds, and this can be when they are 18-25 years. This may be a better option if your child doesn’t go to college, and you want them to access the funds when they are older.

What Assets Can You Hold in UGMA Accounts?

Although a UHMA is somewhat restrictive, you can still hold a variety of assets in the account.

How Do UTMA Accounts Differ in Asset Flexibility?

Many people choose to set up UTMA accounts instead, as it offers more flexibility in terms of what types of assets you can own. For example, if you set up a UTMA, you can invest in other assets like real estate, fine art, patents and royalties.

UTMAs may also invest in traditional assets, including stocks, bonds, mutual funds, and other investments. For many, this extra freedom can allow one to pursue alternative investments and to achieve greater portfolio diversification.

UTMA vs UGMA Tax Considerations

The UTMA and UGMA options provide you with more flexibility. However, the cost of this flexibility is less tax benefits relative to 529 accounts. It is important to be mindful of several factors related to taxes, and to limit your contributions to provide the most tax benefits for your children.

It is best to make consistent and gradual contributions, as the IRS caps the amount you can send without triggering additional taxes. If you contribute more than $17,000, depending on your filing status, this will trigger a federal tax gift. The IRS often changes this amount each year.

Moreover, earnings are also taxed at various rates once they cross a set threshold. The IRS classifies this investment income as unearned income. Unearned income below $2,500 will be taxed at the child’s rate, while anything above $2,500 will be taxed at the parent’s tax rate.

Another important factor to consider is how assets in these accounts can impact FAFSA eligibility. When you are applying for financial aid, you will have to claim the value of the assets in these assets. In this case, the income you state in your application can increase by up to 20% of the account values.

What’s the Best Choice? 

If you are not sure if your child will go to college, then UTMA or UGMA accounts are usually the best option for you to consider. 529 accounts offer better tax incentives, but you can only use the funds for education expenses.

When you are considering a UTMA or UGMA, one of the first things to think about is when you anticipate that your child will need the funds. If you want your child to receive the funds at a later date, a UTMA may be a more flexible option.

After this, it is crucial to focus on what types of investments you want to hold in the account. A UGMA is great if you want to invest in stocks or bonds. However, if you think you may want to invest in real estate or other alternative investments, then it is definitely better to set up a UTMA.

It is best to plan ahead, and consider some of the tax implications of these decisions. Moreover, it is also crucial to understand that many of these deposits are irrevocable and will automatically be transferred to your children when they are 18 years or older. It may be best to consult an accountant to discuss the tax implications, and to also talk to a financial advisor about your child’s financial goals.

Closing Thoughts

If you want to plan your child’s financial future, getting an early start and setting up a UTMA or UGMA could be a solid option. These plans can benefit your children whether they use the funds for education or other purposes. It is ideal to talk to an account and/or financial planner to figure out which account is the best fit for your family’s financial goals. All transfers are irrevocable, so it is important to make the right choice in the beginning.  Get started now for a one-on-one strategy session with one of our veteran tax pros.

About the Author

Miguel Alexander Centeno

Miguel Alexander Centeno is an author, speaker, and tax leader at Shared Economy Tax. A former Big 4 tax manager, he represents taxpayers in all matters before the IRS, including the U.S. Tax Court. He has been quoted in the Wall Street Journal, Fox Business, and MSNBC on tax related articles and has testified before the U.S. House of Representatives as a part of hearings for the Tax Cuts and Jobs Act. A father of three, Miguel is an avid acoustic guitar player, gravel cyclist and once-a-week yogi.
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