Saving For College: UGMA and UTMA Custodial Accounts

Saving For College: UGMA and UTMA Custodial Accounts

When it comes to saving for college, you have a lot of options, from 529 plans to Coverdell Education Savings Accounts and pre-paid tuition plans. But old-fashioned custodial trust accounts are also an option.

All contributions to an
UGMA or UTMA account
are considered "irrevocable"
gifts. That means once made,
all contributions belong to
the beneficiary and cannot
be taken back.

Today, 529 plans and Coverdell Education Savings Accounts (ESAs) get a lot of the attention for saving for education expenses, but back before they even existed, many families used custodial trust accounts structured as either a Uniform Gift to Minors Act (UGMA) account or a Uniform Transfer to Minors Act (UTMA) account.

If you are trying to determine the best way to save for your child or grandchild's future, here are five things you need to know about UGMAs and UTMAs.

1. Who Can Open One?

Any parent, grandparent or other adult can transfer assets to an UTMA or UGMA account. The donor can serve as custodian on the account, or appoint someone else to do so.

The custodian acts in the child's interest and makes all investment decisions on the child's behalf until she reaches the age of majority in the state in which she resides. The age of majority typically ranges from 18 to 21 years old, depending on the state.

And it's worth noting: the beneficiary is permanent. While some other college savings vehicles allow you to change an account's beneficiary, that isn't the case with UTMAs and UGMAs.

2. What is the difference between an UGMA and an UTMA?

Some states allow UTMA accounts, while others allow UGMA accounts. Both accounts are largely the same, but differ in the kind of assets you can contribute to them.

UTMA accounts allow for the contribution of virtually any kind of asset, including real estate. UGMA accounts, on the other hand, are limited to gifts of cash, securities (such as stocks, bonds or mutual funds) and insurance policies.

For either account, there is one custodian and one beneficiary and all contributions are considered an "irrevocable" gift. That means once made, all contributions belongs to the beneficiary and cannot be taken back.

3. Are there tax advantages?

Yes, but unlike 529 plans and ESAs, these accounts are not tax deferred. Instead, for beneficiaries that are younger than 19, or younger than 24 and a full-time student, the first $1,050 of unearned income in an UTMA or UGMA account is tax free. The next $1,050 in income is taxed at the child's tax rate (assuming she has no additional income).

Unearned income over $2,100 is taxed at the custodian's federal tax rate. To learn more about the tax rules for children, you should read the IRS's Tax Rules for Children and Dependents.

4. Are there any limits?

There are no annual or lifetime contribution or income limitations for UTMAs or UGMAs. However, the custodian would be subject to the federal gift tax if the total contribution exceeds $14,000 in a year (or $28,000 for married couples filing jointly).

At the same time, there are also no limits on the use of withdrawals. Withdrawals can be used for any purpose, not just qualified education expenses, without penalty.

For some, the lack of limits may be a good thing. For example, if a beneficiary got a full scholarship, the money could be used for other expenses, such as a down payment down the road. But there is also nothing to stop a beneficiary from spending that money on a fancy vacation or new car once they reach the age of majority.

Parents looking for more control over how the money can be spent may want to explore other options, like a trust, where there is more flexibility to determine when control of the assets is given to a child or dependent, or other college savings vehicles that restrict how savings may be used.

5. Are there any other possible drawbacks?

One potential disadvantage lies in how assets held in an UGMA or UTMA are treated when it comes to financial aid. The assets held in UGMA and UTMA accounts are considered the student's assets, whereas assets held in 529 plan or ESA accounts are treated as parents' assets.

That matters because student assets are weighed more heavily than parent assets on the Free Application for Federal Student Aid (FAFSA). Colleges will expect students to use up to 20 percent of their assets to pay for college whereas they will expect parents to use up to 5.64 percent of unprotected assets to pay for college.

6. Can a UGMA or UTMA account be transferred?

You can transfer funds from an UGMA or UTMA account, or other custodial account, to a 529 plan if the plan accepts such transfers, but that new 529 plan must also be set up as a custodial account. A custodial 529 plan is treated as a parent asset on the FAFSA.

However, in order to make the transfer, you must liquidate any investments you have made in the custodial account, and you must pay taxes on any gains made on those investments.

While you can change the beneficiary on a traditional 529 plan account, you cannot do so on a custodial 529 plan account after the transfer of assets from an UGMA or UTMA account.

For more information on other college savings options, be sure read up on 529 plans and Coverdell Education Savings Accounts.

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