In our saving 4 college series, we’ve discussed several types of college savings accounts, now it’s time to dive into Utma and UGMAs.

UTMA and UGMA accounts are types of investment accounts that can help parents save money for their child’s college. With a UTMA or UGMA account, parents are able to contribute a certain amount to their children as a “gift” each year without paying taxes. Once your child reaches the age of majority in your state, they can take control of the account and begin using it to cover the cost of school expenses.

In this chapter, we’ll take a closer look at UTMA and UGMA accounts to help you learn more about them. We’ll talk about what these accounts are, how they work, and how they’re different from each other. Then, we’ll compare UGMA vs. UTMA accounts to 529s and ESAs to help you make informed investments to save for college for your child.

Keep reading or use the links below to get started.

• What Are UTMA & UGMA Accounts?
• Why Use These Accounts?
• UTMA vs. UGMA: What’s the Difference?
• UTMA and UGMA Benefits
• UTMA and UGMA Drawbacks
• UTMA or UGMA vs. 529
• UTMA or UGMA vs. Coverdell ESA

What Are UTMA & UGMA Accounts?

UTMA (Uniform Transfer to Minors Act) and UGMA (Uniform Gifts to Minors Act) accounts are designed for people to use to save for college. Essentially, these accounts allow you to gift a certain amount to a child, but your child can’t own these assets yet. Instead, these assets are owned by a custodian who manages the UGMA or UTMA account until your child reaches the age of majority in your state, which is generally 18.

It’s important to keep in mind that unlike ESAs and 529 plans, UTMA and UGMA accounts aren’t specifically designed for college savings. While some parents use these accounts to save for college, they’re different from 529 plans and ESAs in terms of the benefits they offer. It’s also important to consider the age of majority in your jurisdiction before investing in a UGMA or UTMA account.

Why Use These Accounts?

The primary reason for using UGMA and UTMA accounts is to transfer assets to a minor without having to set up a trust or wait until your child turns 18. In this sense, a UGMA or UTMA account can help you start saving for college when your child is still a minor, which can help you build a larger fund by the time they go to college.

One of the benefits of using a UTMA or UGMA account is the fact that you get a wider range of investment options compared to 529 plans. While gifting a UGMA or UTMA account often involves money, you can also gift other assets like patents, royalties, real estate, and fine art. Keep in mind that contributions above a certain amount will be taxed.

UTMA vs. UGMA: What’s the Difference?

You might be wondering, what’s the difference between a UTMA vs. UGMA? UTMA stands for Uniform Transfer to Minors Act, while UGMA stands for Uniform Gifts to Minors Act. So, how are these gifts and transfers different?

For starters, the UGMA was passed back in 1956 and revised again in 1966. It wasn’t until 30 years later that the UTMA was passed, and the UTMA still hasn’t been adopted in every state. Consequently, only parents who live in a state that’s adopted UTMA can use these tax-free transfers.

The type of account you choose determines the types of contributions you can make to your child’s account. 

• With a UTMA account, you can invest financial assets, which includes things like stocks, bonds, and cash. 
• With a UGMA account, you can invest financial assets in addition to physical assets, including real estate and fine art.

Starting a UTMA or UGMA account for your child can be a good way to start saving, but having a good understanding of the basics is important before you can make a decision. If you need help learning how to budget or invest, you might consider talking to a financial advisor.

UTMA and UGMA Benefits

As a parent saving for your child’s college, it’s important to weigh the pros and cons of UTMA / UGMA accounts compared to the other investment accounts we discussed earlier, such as ESAs and 529 plans. Here are some of the benefits of choosing a UTMA or UGMA account for your child.

Tax-Free up to $16,000

The biggest advantage of using UTMA and UGMA accounts is the fact that you can contribute up to $16,000 tax-free. Any earnings on a UTMA or UGMA account are taxed at your child’s tax rate, which may be a lot lower than your tax rate. 

Your child may not even be required to file a tax return if a UTMA or UGMA account is their only income.

Flexible Investment Options

Depending on the type of account you choose, you can contribute real estate, fine art, and other physical assets in addition to financial assets. This makes UTMA and UGMA accounts a bit more flexible than ESAs and 529 plans.

Because UTMA and UGMA accounts are tax-advantaged and available for children, they can be an effective tool for saving for college. That being said, your child should understand the importance of managing money after college and during college to maximize your investment.

Can Be Applied to More Expenses

Since UTMA and UGMA accounts aren’t specifically designed for education, there are no limits regarding how your child can spend the money. This means your child can use their UGMA or UTMA account earnings to pay for any expenses they may have, including housing and food.

All things considered, UTMA and UGMA accounts can be highly beneficial for certain people.

UTMA and UGMA Drawbacks

While there are several benefits to opening a UTMA or UGMA account for your child, there are drawbacks as well. Taking these drawbacks into account is a key factor in deciding if a UTMA or UGMA account is right for you and your child.

Affects Financial Aid Eligibility

One of the biggest downsides to starting a UTMA or UGMA account is the way they affect financial aid eligibility. ESAs and 529 plans have a relatively minor effect on financial aid eligibility, but UTMA and UGMA accounts are considered your child’s assets. This means that UTMA and UGMA accounts may reduce financial aid eligibility by up to 25% of the total value of the asset.

Must Wait to Withdraw

Your child has to reach the age of majority before withdrawing from a UTMA or UGMA account, which means they typically must go to college after the age of 18 to use these funds. Children who graduate early or turn 18 after starting college may have a tougher time paying for college with these accounts.

UTMA or UGMA vs. 529

Earlier in the series, we talked about 529 plans and how they work. If you’re having trouble choosing between a UTMA or UGMA account and a 529 college savings plan, here’s a quick comparison.

Taxes

As far as taxes go, 529 plans have the advantage over UTMA and UGMA accounts:

• There are no contribution, income, or age limits with a 529 account, so you can contribute as much as you’d like. 
• Contributions up to $16,000 per donor, per child are tax-free. 
• When your child needs to use their 529 earnings to pay for college, they can withdraw up to $10,000 per year tax-free.

Use of Funds

Unlike UTMA and UGMA accounts, 529 plans must be used to pay for qualifying education expenses. These expenses may include tuition and room and board. This limits your options a bit when it comes to paying for college.

Financial Aid

529 plans also have a minor effect on your child’s financial aid eligibility while UTMA and UGMA accounts can take a serious toll. This isn’t a huge deal if your child attends a more affordable college, but it can affect their ability to secure financial aid to attend a university.

UTMA or UGMA vs. Coverdell ESA

Coverdell ESAs are another type of education investment account we talked about earlier in the series. These education savings accounts are similar to 529 plans, but there are some important differences to consider.

Contribution Limits

Unlike UTMA and UGMA accounts, ESAs have contribution limits. You can only contribute $2,000 per child, per year. Your income may prevent you from investing in ESAs, or it may limit the amount you’re able to contribute each year.

Withdrawals

Withdrawals are tax-free as long as they’re used to pay for qualifying education expenses. 

Financial Aid

Like 529 plans, ESAs are considered the parents’ asset, which means they have a minimal effect on financial aid eligibility.

When considering a UTMA or UGMA account vs. a Coverdell ESA, consider calculating the cost of living and looking at other expenses your child may have.

In Conclusion

UTMA and UGMA accounts are one of several options you have when it comes to saving for college for your child. Alternatives to UTMA and UGMA accounts include Coverdell ESAs and 529 plans. Consider consulting a financial advisor if you’re not sure which account type is right for you.

In the next chapter, we’ll complete the series with a big-picture comparison of the various types of savings vehicles you can choose from for saving for your child’s college fund.

The post Chapter 7: UTMA & UGMA Accounts: What Are They? appeared first on MintLife Blog.