UGMA and UTMA accounts are custodial taxable investment accounts designed for children. The Uniform Gift to Minors Act was created in the 1950s and later expanded into the Uniform Transfers to Minors Act about a decade later. The main difference is that UTMA accounts allow a wider range of investments, including assets like real estate and certain insurance policies, while UGMA accounts are generally limited to stocks and bonds. Today, most states use UTMA accounts, with the exception of Vermont and South Carolina, which still use UGMA accounts. In practice, the two function very similarly for most investors.
When you contribute money to a UTMA account, you are making an irrevocable gift to your child. The account is managed by a custodian until the child reaches the age of majority, typically around age 21 in most states. At that point, the money legally becomes theirs and they can use it however they choose. Unlike a 529 plan, which is specifically designed for education and remains under the parent's control, UTMA funds can eventually be spent on anything. That could include a car, travel, a wedding, or even things you might not approve of, which is an important consideration before contributing.
One reason families use UTMA accounts is for potential tax benefits. A small amount of the investment income generated each year is tax free, and the next portion is taxed at the child’s lower tax rate. However, income above a certain threshold is taxed at the parent’s rate under what is known as the kiddie tax. Because of this, it often makes sense to invest these accounts in tax efficient investments such as a broad stock market index fund and keep the account size relatively modest. Many families use UTMA accounts as a flexible gift fund for their children, sometimes called a “20 fund,” that can later be used for things like travel, a car, or a down payment on a home.
UGMA or UTMA accounts are basically custodial taxable accounts for your children. They first came up with a Uniform Gift to Minors Act in like 1950s, and were subsequently revised about a decade later. And that's when UTMA came about. The UTMA was slightly better than the UGMA, and that you can hold things that aren't just stocks and bonds in it. You were allowed to hold some life insurance policies and real estate and those sorts of things in UTMA, but for the most part, they're the same thing. And a UTMA is available in all states except Vermont and South Carolina. In those two states, you still have a UGMA account with its, you know, slightly more restrictive investments. For the most part, though, most people that open one of these accounts for their children. It will be a UTMA account. Now, this is money you want to give to your children when they reach a certain age, typically age 21, in most states, and it becomes their money at that point. So this is not like a 529 account for a college education where it's your money. This becomes their money. At a certain point, they can go spend it on anything they want, right? If they want to go use it to buy a car or give it away to somebody you don't approve of, or use it for drugs or alcohol, that's up to them. Once they hit that age, it's their money. So why would anybody even think about doing this instead of just giving them money later? Well, a couple of reasons.
The first one is it gets money out of your estate, right? It becomes their money. And so it's a way you can give them a gift amount every year that's not subject to gift taxes. It's not subject to having to file a gift tax return and reduce the size of your estate. But mainly the reason people do it is to save a little bit of money on taxes. You see, the first certain amount of income that it makes every year is totally tax free, and the next little chunk of income that it makes. And these both go up a little bit year to year. And the total between the two is about $3,000 ish. But the next amount is taxable at their income tax rates. The problem is any amount of income above that gets taxed at your tax rate as the custodian. This is known as the kiddie tax. And it's a bit of a pain, which suggests that you probably ought to invest these UTMA accounts very tax efficiently and not let them get too big. If you'll invest them in something like a total stock market account and you'll keep it to a five figure amount, you probably won't have to pay any kiddie tax on it. The yields are just low enough that they will keep you below that amount where kiddie tax has to start being paid. So what do people use these for? Well, if you want to give your kids money like we have that we call a 20 fund money that they can use for anything they want an early inheritance if you will.
A UTMA is a good account for it. If you want to let them use it for to go on a mission, or to do a summer in Europe, or to buy a car, or pay for a wedding or a honeymoon, or a down payment on a house, or those sorts of uses, right, that aren't education. It's education. Use a 529. If it's something else, you can use a UTMA account for it. You get a little bit of tax favorability out of it, right? That money either doesn't get taxed or gets taxed at their income rather than your higher tax rates. But you give up control over the account once they turn 21. It's it's their account to do with as they please even before they reach that age. You can only spend this money for their benefit, right? You can't take the money back out and use it to go buy yourself a boat. It's got to be spent for their benefit. Now that might be a car for them when they're 16 or something, but it's not a boat for you. So keep that in mind as you fund a UTMA account. Is this really is a gift that you're given to your children? You're giving it to them a little bit early, retaining a little bit of control until they get to a certain age in exchange for a little bit of tax benefit. That's really what a UTMA is. It's a custodial taxable account for your kids.
The White Coat Investor podcast is for your entertainment and information only and should not be considered financial, legal, tax or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate
Medical school may not have taught you about money, but we will.
We will never sell your information. Modify your preferences or unsubscribe at any time.
Get ready to take control of your financial life. You can do this, and we can help.
We won't sell your information. Modify your preferences or unsubscribe at any time.