What is UGMA/UTMA?
UGMA/UTMA stands for Uniform Gift to Minors Account/Uniform Transfer to Minors Account, it is an irrevocable transfer of funds to a minor held in an account that is not tax-deferred.
What are the Tax Benefits?
Contributions: not deductible for federal, state or local taxes.
In 2013: For children who are not working and have not yet reached their 19th birthday, and for children who are college students who are not paying for at least 50% of their own support from earned income, up to $2,000 in unearned income is taxed at the child’s rate: annual income above $2,000 is taxed at the parent’s marginal rate for federal income taxes. The tax rate is 0% for the first $1,000 in unearned income. The rate for the next $1,000 is also 0% (for dividends and long term capital gains) or 10% (for interest and short term capital gains). Unearned income above the first $2,000 will be taxed at the child’s parents’ tax rate.
After the child reaches age 19 and is not enrolled in college, all unearned income is taxed at the child’s tax rate.
If the child has earned income, please review IRS Publication 929: Tax Rules for Children and Dependents. In general, the earned income reduces the amount of unearned income subject to the child’s tax rates, when the above limits apply.
Withdrawals: Capital Gains are taxed at the child’s tax rates, subject to the above limits.
Who is the Owner and Who is the Beneficiary?
The account custodian retains control of the funds until the child reaches the age of majority (usually 18 or 21) at which point control is automatically passed to the child-owner.
Does UGMA/UTMA have Contribution Limits?
There is no annual contribution limits. However, gifts of more than $14,000 from an individual may result in gift tax reporting requirements to the donor.
How to Use UGMA/UTMA Funds?
The custodian of an UTMA/UGMA account may only withdraw funds from the account for a use that directly provides a benefit for the child-beneficiary. The custodian may not transfer assets from an UTMA/UGMA account to an account of any kind owned by the custodian (or any person other than the child-owner). The child-owner of the account may not “authorize” the custodian to transfer assets to any account owned by any person.
Important: Account is not revocable or transferable; the custodian may not transfer funds between family members, or reclaim the funds as their own.
What are the Investment Choices?
The investments are directed by custodian until age of majority, and by owner/beneficiary thereafter.
Is there any Impact on Financial Aid?
Since the UTMA/UGMA account is the owner/beneficiary’s property, it will be treated as a student's asset in financial aid formulas. Capital gains, interest, and dividends reported on the student’s tax return may be considered student income by the financial aid formulas.
Some private colleges will treat all “family” assets as parent assets. At colleges that choose this treatment, the UTMA/UGMA account is assessed at the same rate that parent assets are assessed.
What if Funds are Not Used for College Education?
Custodian or beneficiary may use the funds for any purpose without penalty or special tax consequence, as long as the use directly benefits the beneficiary.
What else should I know about UGMA/UTMA?
There is a loophole in the treatment of UTMA/UGMA assets that may allow some families to reduce their impact on financial aid - Assets in 529 Savings Plans, Prepaid Tuition Plans, and Coverdell ESAs that were funded by UTMA/UGMAs are treated more favorably than other student owned assets when schools calculate federal EFCs.
This means that just before filing the financial aid applications, UTMA/UGMA custodians can liquidate the assets in a UTMA/UGMA, use the cash generated to fund a 529 Savings Plan (which must have the child as the participant and the beneficiary and must be registered as an UTMA/UGMA as well as a 529 Savings Plan), and thereby reduce the assessment rate in the federal financial aid formula from 20% to 3-6%. This procedure may result in a capital gains tax obligation, and does impose additional restrictions on the funds that would not have existed prior to the investment in the 529 Savings Plan.
NOTE: Since 529 Savings Plans can only be funded with cash, any investments that are held in the UTMA/UGMA accounts would have to be sold, and a capital gain realized. If the child is in college, or is not yet 19 when this sale occurs, some of the gain might be taxable at the parents’ tax rate.