- Life & Money
- Everyday Money
- Building Savings
- Marianne Hayes
- Nov 18, 2022
There are many ways parents, grandparents and guardians of minor children can save for college and other future expenses. A Uniform Gifts to Minors Act (UGMA) account is one such savings vehicle. It’s a type of custodial account that allows adults to transfer financial assets to children.
Custodial accounts can be structured as savings or investment accounts and are managed by the adult custodian until the child comes of age. At that point, the child (now legally an adult in his or her state) assumes full ownership, and the account will be transferred into that person’s name.
A UGMA account is a unique way to help build your child’s savings. Let’s unpack how it works and how it measures up to other custodial accounts.
Uniform Gifts to Minors Act
The Uniform Gifts to Minors Act made its debut in 1956. It has since been adopted by all states, though each state has its own age of majority — the age at which the minor takes control — and its own terms regarding the kinds of assets that may be deposited.
What is a UGMA account?
A UGMA account allows adults to gift financial assets to minors. UGMA accounts can have potential tax benefits such as the first portion of earnings, up to $1,100 is exempt from federal tax and the next $1,100 being taxed at the child’s rate (anything after that is taxed at the parents’ rate).. It can be a cost-effective alternative to establishing a trust. Here’s a more detailed explanation of how it works.
How do UGMA accounts work?
You can open a UGMA account at many brokerages and financial institutions by providing basic personal information, such as the child’s Social Security number and birth date. There may be a minimum opening deposit, which generally ranges from $500 to $2,000.
What assets does a UGMA account include?
A UGMA account can hold all kinds of financial assets, typically including stocks, bonds, mutual funds and other publicly traded securities. The adult serves as the account’s custodian, meaning that person will make decisions on behalf of the child, from managing contributions to selecting investments and making withdrawals.
A UGMA account’s custodian can withdraw funds if the money is used to benefit the child. It’s important to note that the custodian cannot revoke contributions or use UGMA funds for another child. In other words, the adult is expected to serve as a fiduciary who acts in the child’s best interest.
While the custodian manages the account, anyone can add funds or assets. This allows family members and friends to gift financial assets to the child. Minors will take over their accounts upon reaching their state’s age of majority, which typically ranges from 18 to 21. At that point, they will have full control of the account and can manage their assets as they see fit.
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UGMA account vs. UTMA account
It’s not uncommon to hear the term UGMA account used with another type of custodial account known as a Uniform Transfer to Minors (UTMA) account. While these accounts are similar, UTMAs are a little more flexible because they can hold a wider range of investments, including physical assets. Cars, real estate, art and jewelry may all be on the table. Annuities, intellectual property and life insurance policies might also be placed in a UTMA.
Depending on where you live and how the account is structured, UTMA accounts might also allow for a later age of majority. The right type of custodial account for you will depend on your state rules and the types of assets you plan on transferring to the beneficiary.
UGMA vs. 529 plan
UTMA and UGMA accounts are sometimes used to help save for college. However, when thinking about college savings today, most people likely think of a 529 college savings plan. While UGMAs and UTMAs can be used to save for college, money in these accounts can ultimately be used for any purpose.
The 529 plans offer a tax-friendly way to pay for college, but funds in a 529 are restricted to education expenses. Using 529 funds to pay for non-qualified expenses will likely trigger a 10 percent penalty and taxes on earnings. A UGMA account provides more flexibility and can be used for anything — from paying for college to buying a home to starting a business.
Pros and cons of a UGMA account
As with any financial account, there are benefits and potential concerns to consider with a UGMA account.
Pros of a UGMA account
- A portion of unearned income in a UGMA account is taxed at the child’s tax rate, which will likely be lower than the parents’ rate.
- There are no contribution limits (with a caveat). You can contribute up to $17,000 in 2023 annually to a UGMA account without any tax repercussions (married couples can give twice this amount). Anything more than that will count toward your lifetime gift-tax exclusion limit. In 2023, that amount is just under $13 million.
- Funds can be used for anything, and there are no withdrawal penalties.
- UGMA accounts are easy to set up and manage.
Cons of a UGMA account
- A UGMA account could impact the beneficiary’s financial aid eligibility because the assets technically belong to the minor.
- Unlike with a 529 college savings plan, the custodian cannot change the beneficiary of a UGMA account.
- Tax breaks are less robust when compared to a 529 plan.
Is a UGMA account right for your financial plan?
A UGMA account could be a valuable financial tool that allows you to transfer financial assets to a minor. UGMA accounts provide a good deal of flexibility and might be a viable alternative to a trust. If saving for college is your main goal, keep in mind that UGMAs don’t offer as many tax advantages as a 529 plan does. Whether a UGMA account is right for you really boils down to your unique financial situation and goals.
Connecting with a financial advisor may help guide you toward the best savings vehicle. An experienced advisor can also offer personalized financial planning advice that goes beyond custodial accounts.
This publication is provided for informational purposes only and should not be interpreted as financial, tax, or legal advice. Northwestern Mutual and its representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation. All investments carry some level of risk, including the potential loss of principal invested.