UTMA and UGMA Accounts: Pros, Cons, Rules

Established in 1956, UGMA Accounts are the oldest form of custodial accounts with tax benefits. UTMA Accounts were established in 1986 and are a special flavor of UGMA. 

These days, 529 Plans and Education Savings Accounts are common ways to save for higher education. However, Uniform Gift to Minors Act Accounts, UGMA, and later Uniform Transfers to Minors Act Accounts, UTMA, were once considered a primary way to save for children’s college education. 

Despite how uncommon it may be, UGMA accounts and UTMA accounts still provide a flexible investment account for children. An adult can invest for the benefit of a child until the child takes over the account between the ages of 18 to 21. 

Here’s what you need to know about this class of custodial investment accounts.

What Are Custodial Accounts For Minors?

Custodial accounts are investment accounts where an adult saves and invests money on behalf of another person. Parents and grandparents often use it to help their children pay for college, buy a house, or pay for a wedding, to name a few.

These accounts don’t offer the same tax advantages as 529 Plans and Education Savings Accounts, but they offer more flexibility for the beneficiary once they take over the account. 

Uniform Gift to Minors Act (UGMA) vs. Uniform Transfers to Minors Act (UTMA) Accounts

UGMA and UTMA accounts are both custodial accounts designed to transfer wealth to minors. 

The primary difference between the two is the type of assets allowed in each account. UGMA accounts only allow financial assets like cash, stocks, and mutual funds. 

UTMA accounts allow any tangible assets including cars, jewelry, real estate, and more. If you have significant alternative investments that you want to pass on to your kids, a UTMA account may be the best way to do that.

Keep in mind that UTMA accounts aren’t allowed in Guam, South Carolina, Vermont, or the Virgin Islands.

In general, beneficiaries will take over UGMA and UTMA accounts between the ages of 18 to 21. However, many states have a higher age of majority limits for UTMA accounts compared to UGMA accounts.

While the accounts don’t offer any tax advantages for contributing to the account, parents may get a small tax break on the earnings. 

Unearned interest in a child’s investments is subject to kiddie tax rules. In 2023, the Kiddie tax rule will provide a small shelter on up to $2,500 earned in an investment account owned by a minor (including a UGMA).

Once the beneficiary reaches the age of majority, they take over their UGMA account. After that, they can use the money for whatever they choose. The beneficiary might use it for their education, but they could also use the assets to start a business or take a trip to Hawaii. The original investor has no say in the funds once the beneficiary takes over the account.

UGMA And UTMA Account Rules

UGMA/UTMA accounts have fewer rules than 529 plans or Education Savings accounts. However, adults need to be careful to manage these accounts properly. 

Account funders must remember that the accounts are subject to gift tax limits. In 2023, you cannot put more than $17,000 in a custodial account without reporting gift taxes on the additional gift.

The owner of the account (often the parents or grandparents) will pay taxes on the income earned within a UGMA or UTMA account. The Kiddie Tax Rule reduces the overall tax burden on the investment income, but the account owner still has to pay taxes on the earnings.

• Flexibility in the use of funds. Beneficiaries can use the funds in a UGMA/UTMA account however they want. This can be a great way to give money to a child if you hope for them to use it to start a business, pay for a wedding, or put a down payment on a house. Plus, there’s no penalty like you get on a 529 plan.
• Assets belong to the beneficiary. There’s never any confusion about who benefits from a UGMA or UTMA account. The beneficiary of the account will receive the funds at the age of majority in their state. After that, the assets belong to the beneficiary. 
• A wide array of investment options are available. UGMA accounts house any financial assets, and UTMA accounts can include physical assets as well. You aren’t limited to the investment options chosen by your state’s 529 plan.

• No tax advantages for contributions. UGMA and UTMA plans offer no tax advantages for “contributions”. You can contribute up to the Gift Tax Limit in a given year.

• No oversight for the use of funds. Once the beneficiary takes control of the account, the original owner can’t stop the beneficiary from using the money. While the beneficiary may use the money wisely, they could also blow the money on a foolish expenditure or a misguided investment.

• Limited tax advantages on income. Tax owners will receive a small tax deduction ($1,250 in 2023) on the unearned income, and they will pay the child’s tax rate for the next $1,250. After that, the tax rate on the income is paid at the account owner’s rate. While owners may enjoy a small tax break, the overall savings is limited.

Bottom Line

Perhaps the most important rule for parents to remember is that this account is a no-strings-attached transfer of wealth. When the beneficiary hits age 18 to 21, the account is theirs. They can do what they want with the money. 

If this is important to you and you’re not too concerned about tax benefits—for example, earnings in a 529 plan grow federally tax-deferred, giving your funds an opportunity to compound faster. If you’re simply wanting to pass on assets to your child, a UGMA or UTMA could be a good option.  

Just remember the gift tax limits.