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Saving and investing for college expenses may seem overwhelming, but setting aside even small amounts can give your child a head start. While many people are aware of tax-efficient investing accounts like 529 plans, you may not know about UGMA/UTMA accounts – another way to save for educational and other expenses.
In this article, we’ll take a look at UGMA and UTMA custodial accounts, what they are, and how to determine the best way to save for your kids’ future, while getting tax advantages.
What are UGMA and UTMA accounts?
UGMA stands for the Uniform Gifts to Minors Act and UTMA stands for Uniform Transfers to Minors Act. Account-holders are “custodians,” and may transfer money into the account to benefit the minor, but the money is managed by the custodian. Typically the money is released to the minor at the age of majority (usually 21 but sometimes 18 or other ages).
How do UGMA and UTMA accounts differ from 529 plans?
529 plans differ from UGMA/UTMA account in a few key areas:
- 529 plans can only be used for educational expenses, while UGMA/UTMA accounts can be used for anything that benefits the child. .
- 529 plans are owned and controlled by the person who created the account – with UTMA/UGMA accounts, the funds are transferred to the beneficiary at the age of majority.
- Unlike 529 plans, custodial accounts are considered the property of the child, which means that it counts for a higher percentage in financial aid calculations.
The two types of plans share some similarities:
- Both types of accounts are considered custodial accounts that can be used for the benefit of a minor.
- Anyone can contribute to either type of account — there are no restrictions based on one’s personal income
If you have a medium to long-term horizon, either a UGMA/UTMA account or a 529 account is usually better than just putting your money in a savings account at a low-interest rate. And don’t forget that it is possible to have both a 529 plan AND a UGMA/UTMA account for the same child.
Why You Need to Open a UGMA/UTMA Account for Your Kids
Unlike with a 529 plan, the funds in a custodial account do not have to be used solely for higher-education expenses. The custodian can withdraw money in a UGMA/UTMA custodial account for any expense that benefits the child, like technology, transportation, housing, or any other expense for the child.
The biggest advantage of UGMA/UTMA custodial accounts is their flexibility. Because they can be used for a wide array of expenses, you can use the money in the account even if your child chooses not to go to college. While earnings do not grow completely tax-free like in a 529 plan, earnings in a UGMA/UTMA account are tax-advantaged, but in a different way.
Depending on how you file your tax return, a guardian can choose to include their child’s unearned income with their own tax return. Unearned income is money that doesn’t come from employment, like from interest or investments. In 2020, the first $1,100 of a child’s unearned income can be claimed on the guardians’ tax return tax-free, and the next $1,100 is taxed at the child’s tax rate, which is likely much lower than their parent’s.
Things to watch out for with UGMA or UTMA accounts
If you’re looking to save money or transfer assets to your kids for a variety of expenses beyond education, a UGMA/UTMA custodial account can make a lot of sense. One thing to watch out for is that a UGMA/UTMA account is tied specifically to one named beneficiary. Unlike a 529 plan, where you can transfer the money in an account to a sibling or other beneficiary, with a UGMA/UTMA account, any unused funds must be used or distributed by the time the child reaches their age of majority or their state’s maximum age for custodial accounts.
Apps like Acorns are making it easy to start a UTMA/UGMA account with their new product, Acorns Early. You can start in under a few minutes and set Recurring Investments starting at $5 a day, week, or month. Fun fact: If you invest $5 a day from birth, considering a 7% average annual market return, you could have more than $70,000 by the time the child turns 18. To learn more, visit Acorns.com/Early.
Dan Miller is a freelance writer and founder of PointsWithACrew.com, a site that helps families to travel for free / cheap. His home base is in Cincinnati, but he tries to travel the world as much as possible with his wife and 6 kids.