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There are two types of custodial accounts: the Uniform Transfers to Minors Act (UTMA) account and the Uniform Gift to Minors Act (UGMA) account. A custodial account is designed to hold and protect assets for minor beneficiaries. These accounts are set up by a donor (usually a child’s parent/s) so that the donor, another adult, or institution manages money for a minor child. These accounts transfer wealth without the cost and complication of setting up a formal trust.[1],[2]

Key aspects of both accounts:

  • After this money is placed in a custodial account, it cannot be taken back. This is an irreversible gift.[3]
  • In 2022, $16,000 per individual and $32,000 for a married couple can be contributed free of gift tax.[4]
  • Minors will have complete control of the money when they reach maturity. There are no stipulations that they need to use it for education or anything else. They can spend as they please.[5]
  • Account money can be withdrawn for the needs of the minor that the account was set up for, but the minor does not have full access to the funds until they reach adulthood- the account and the state will determine the age of maturity. 1,2, 3
  • There is a fiduciary responsibility of the custodian, or if they designate another person or institution that they will act in the interests of the receiver of the account, not the donor. The custodian must also comply with the particular state’s UTMA/UGMA statutes. 1,2, 3
  • These accounts can be a great way to teach children about investing. 1,2, 3
  • There are no income or contribution limits. 1,2, 3
  • There are no withdrawal penalties. 1,2, 3
  • There are no required distributions at any point. 1,2, 3
  • Any income earned by the account is taxed to the child. However, children are taxed at a lower rate than adults- this is known as a “kiddie tax.”
    • The first $1,050 of earnings is tax-free. The second $1,050 is taxed at the child’s tax rate. Over $2,200 is taxed at the trust and estate rate. 1,2, 3
  • With all investment accounts, you expose some or all your invested money to loss for the chance to earn a higher profit. Investment gains hinge on an ongoing and long-term investment strategy that uses your risk tolerance and diversification to mitigate some risks. Even with these in place, you are exposing your money to loss.
  • Fees vary from institution to institution. It is essential to understand how much you are paying in fees.
  • When the child reaches the “age of maturity,” the account transfers to the beneficiary’s name. After that, they will need to re-register the account as a non-qualified brokerage account, an IRA, or cash out the account and pay the associated fees and taxes. 4
  • These accounts are counted on financial aid applications as income for the child. 1,2, 3
  • These accounts might not be the best option to do large transfers of wealth. Their tax sheltering ability is limited. You will need to speak with a CPA and Financial Planner to see how these accounts could work with an estate planning strategy geared towards your personal situation. 3

Key aspects of UTMA Accounts: [6],[7]

  • UTMA custodial accounts can be used to hold stocks, bonds, mutual fund shares, real estate deeds, intellectual property, fine art, precious metals, and shares in a family-limited partnership.
  • UTMA offers a broader holding capability than UGMA, which will determine if this account works for the donor and beneficiary.
  • The age of maturity is up to 18.

Key aspects of UGMA Accounts: 5,6

  • UGMA custodial accounts can be used to hold purely financial products such as cash, stocks, mutual funds, bonds, other securitized instruments, and insurance policies.
  • UGMA accounts offer a more extended maturity date which might be helpful to beneficiaries that know they will be using its money for undergraduate and post-graduate school to elongate the ‘kiddie tax” rate for as long as possible.
  • The age of maturity is up to 25. If the beneficiary is not in school, this maturity date is lower and depends on state statutes.

If you would like to explore the additional ways to help prepare a child for college and beyond, Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here.

Sources:

[1] https://www.thorleywm.com/sites/g/files/awx1571/f/documents/Custodial%20Accounts%20for%20Education%20Savings.pdf

[2] https://www.investopedia.com/terms/c/custodialaccount.asp

[3] https://www.schwabmoneywise.com/essentials/custodial-accounts

[4] https://www.investopedia.com/terms/u/ugma.asp

[5] https://finaid.org/savings/ageofmajority/

[6] https://www.thebalance.com/beginners-guide-to-ugma-and-utma-custodial-accounts-4060475

[7] https://smartasset.com/investing/ugma-vs-utma

https://budgeting.thenest.com/custodial-account-vs-guardian-account-31639.html

Advisory services offered through Capital Asset Advisory Services, LLC, a Registered Investment Advisor. This material has been prepared for informational purposes.