You may have considered a custodial account if you want more flexibility regarding how your child's education funds are allocated. That way, the money doesn't have to be used for education, but you will still get some tax benefits.
Some states offer UGMA (Uniform Gifts to Minors Act) accounts, and others offer UTMA (Uniform Transfer to Minors Act) accounts. Although these accounts are similar, the type of assets you are eligible to contribute to the account and the maturity age at which the beneficiary is permitted to access the account may differ.
Tax Benefits
Any child under age 18 (or age 24 for full-time students) with federal income tax paid by their parent or guardian is entitled to a specific amount of unearned income at a reduced tax rate.
For the 2022 tax year, the first $1,150 in a UTMA or UGMA is considered non-taxable, and the next $1,150 is taxed at the child income tax rate. Anything over $2,300 is taxed at the parental rate, which can be as high as 37%. This exemption is based on per child, not per account.
Assets you can contribute.
UTMA accounts will allow you to contribute different types of assets. You can contribute almost any asset, including real estate, to a UTMA account.
You can only deposit insurance policies, cash, and securities, including bonds, stocks, and mutual funds, into a UGMA account.
Eligible expenses
A custodian can initiate a withdrawal on behalf of the minor, provided the expenses are for legitimate needs. All expenses for the child's benefit, such as expenses for pre-university education, may be paid to the guardian's account at the custodian's discretion.
However, unlike other college savings accounts, these expenses are not limited to educational purposes alone and can be used for anything related to the child's welfare. The beneficiary is allowed to use the money without limitations upon becoming a legal adult.
Impact on Federal Financial Aid Eligibility
If your child has a deposit account, it is considered an asset and must be added to the FAFSA. Students must contribute at least 20% of their assets towards educational expenses.
Note
While parents may want the funds or assets in a UTMA or UGMA account to be used for college, once the beneficiary gets to the legal age, they can use the money for something else.
Contribution Limits
There are no contribution limits for UTMA or UGMA. However, there are certain tax consequences that you should be aware of.
Each year, either parent can give each of their children $16,000 a year, or $32,000 from both parents, without using the lifetime gift tax exemption. Also, grandparents can give the same annual amount to their children and grandchildren without using lifetime tax exemptions.
If you plan to invest more money than that, you might want to consider setting up a fund or putting some of the money in a 529 account.
Consult a financial advisor if you plan on getting closer to using the lifetime gift tax exemption.
When can beneficiaries access UGMA and UTMA accounts?
UGMAs and UTMAs are custodial accounts used to hold and protect children's assets until they reach the legal adult age in their state. Depending on the state, the legal age can be 18, 21, or 25.
As soon as the beneficiary reaches the legal adult age, the account becomes theirs. They have full control over the account and can decide how they want to spend the money.
Possible Disadvantages of UGMA and UTMA
While the first $2,300 of income is sheltered from higher taxes, the rest of the added money is taxed at the parent's marginal tax rate. This would not be an issue with college funds held in a Coverdell ESA or Section 529.
The account format also requires a guardian to hand over total control of the assets to the child between the ages of 18 and 25, depending on the state and the account.
Not everyone in their late teens and early twenties is responsible. Although many children use the funds for college or other productive pursuits, there is always the risk that the recipient will act irresponsibly without parental supervision.
Which is better, a UGMA/UTMA pass or a 529?
The right college savings plan for you depends on your family's situation. A 529 plan generally offers better tax benefits, but the money should be used for education. Although the UGMA and UTMA plans have fewer tax advantages, they do not have to be used for education expenses. If you are sure the funds will be used for education, a 529 plan will probably be better for your family. If you think the money can be used for education or something else, a UGMA or UTMA plan can be best for your family.
When is the right time to start saving for college?
Yesterday was the best time; today is the next best time. It is best to start saving for your kid's college education as early as possible. This way, your money has more time to work for you, thanks to the power of compound interest.
How much should I save for my children's college education?
Your college savings goal should be based on what you can comfortably afford and what you expect to be in college when your kids turn 18. If you can, you can discuss these issues with your family or a financial advisor to determine what savings goals can be made and turn that into a monthly savings plan.
Summary
Depending on the state and specifics of the account, the beneficiary of a UGMA or UTMA can receive money into the account between the ages of 18 and 25.
The tax advantages of UGMA and UTMA are identical, and the first $2,300 is not taxed.
UTMAs allow the transfer of virtually any asset, while UGMAs only allow bonds, insurance policies, and cash.
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