Using an UGMA or an UTMA for College Savings

If you want more flexibility in terms of where your child's education fund goes, you may have considered a custodial account. That way, the money won't necessarily have to be used for education, but you'll still get certain tax benefits.

Some states offer Uniform Gift to Minors Act (UGMA) accounts and other states offer Uniform Transfer to Minors Act accounts (UTMA). Although these accounts are very similar, the type of assets you can contribute to the account and the age at which the beneficiary can access the account may differ.

How UGMA and UTMA Accounts Work

Tax Benefits

Every child younger than 18 (or up to 24 for full-time students) who files federal income tax as dependents of their parents or guardians is allowed a certain amount of unearned income at a reduced tax rate.

In 2022, the first $1,150 in a UGMA or UTMA was considered tax-free, and the next $1,150 was taxed at the child's income tax rate. Anything above $2,300 is taxed at the parents’ rate, which may be as high as 37%. This exemption is per child, not per account.

Assets You Can Contribute

UTMA accounts will allow you to contribute more types of assets. You can contribute almost any type of asset, including real estate, to an UTMA account.

You can only contribute cash, insurance policies, and securities, including stocks, bonds, and mutual funds to an UGMA account.

Eligible Expenses

A custodian can initiate a withdrawal for the benefit of the child, as long as the expenses are for legitimate needs. Any expense that is for the benefit of the child, such as pre-college educational expenses, may be paid from the custodial account at the custodian’s discretion.

Unlike other college savings accounts, however, these expenses are not limited to education and can be used for anything related to the child. Upon becoming a legal adult, the beneficiary can use the money without limitations.

Impact on Federal Financial Aid Eligibility

If your child has a custodial account, it will be considered an asset and will need to be added to the FAFSA. Students will be expected to contribute at least 20% of their assets towards their educational expenses.

Contribution Limits

There are no contribution limits for UGMAs or UTMAs. However, there are some tax consequences that you should keep in mind.

Every year, each parent can give each of their children $16,000 per year, or $32,000 from two parents, without having to use the lifetime gift tax exemption. Grandparents can also give the same annual amount to each of their children and grandchildren without having to use any lifetime gift tax exemption.

If you're planning on putting more money than that in, you might want to consider setting up a trust or putting some of the money into a 529 account.

If you're planning on getting close to needing to use the lifetime gift tax exemption, you may want to consult a financial advisor.

When Can Beneficiaries Access UGMA and UTMA Accounts?

UGMA and UTMA are custodial accounts, which are used to hold and protect assets for minors until they reach the age of majority in their state. Depending on the state, the age of majority might be age 18, 21, or as old as 25.

After the beneficiary reaches the age of majority, the account becomes theirs. They have complete control over the account, and can spend the money as they wish.

Potential Drawbacks of UGMAs and UTMAs

Although the first $2,300 in income is sheltered from higher taxes, the rest of the money added is taxed at the parents’ marginal tax bracket.This wouldn't be an issue with college funds held in a Section 529 plan or a Coverdell ESA.

The account format also requires a custodian to hand over control of the assets to the child anywhere from age 18 to 25, depending on the state and account.

Not all people in their late teens and early 20s are responsible. Although many children will use the funds for college or other productive endeavors, there's always a risk that the beneficiary will act irresponsibly without parental oversight.

Frequently Asked Questions