Still, some families may crave the flexibility UGMA/UTMAs and Coverdells provide. There are other reasons to use these accounts as well, depending on the circumstances. Here’s what you need to know before deciding which kind of account is best for your family.
The advantages of UTMAs
UGMA and UTMA accounts are very similar, but UTMAs allow a wider range of assets such as real estate, fine art, patents and royalties. These accounts are not only for college savings, but many families use them for this purpose.
UGMAs/UTMAs allow you to make unlimited contributions to the account (though gifts over $15,000—or over $30,000 for couples—could be subject to the gift tax). In exchange, earnings under $2,200 are either untaxed or taxed at the child’s much lower rate. (Note that these amounts are for 2021 and are indexed for inflation.)
Once the money is deposited, it belongs to your minor child and must be used for your child’s benefit. Your job as custodian is to keep the money safe.
Depending on the state, your child will take control of the account at age 18, 21 or 25. The money can be used for any purpose, unlike a 529, which can generally only be used for higher education expenses. If the 529 is not used for one child, it can be transferred to another child or relative, or even yourself, as long as the money is used for qualified education expense purposes.
Another plus: While the investment options in 529s are usually limited to choices offered by your plan, UTMAs give you free rein to invest in anything you want, including individual stocks, mutual funds and real estate.
Yes, there are downsides
UGMAs/UTMAs have drawbacks, which is why many parents, including Michele Claybrook-Lucas of Philadelphia, have switched to 529s once they became available.
When Claybrook-Lucas’s daughter Ciara was born, in 1995, Claybrook-Lucas opened a UTMA to get started on college savings right away. Working for a large financial services firm at the time, she was sold on the benefits of early savings and compounding.
“I started saving consistently, putting aside $250 or $300 a month,” says Claybrook-Lucas, who is now the director of training and workforce development at the Community College of Philadelphia. “We had it for four or five years, but then the 529 came out and I liked the tax advantages, so I stopped saving in the UTMA.”
The UGMA/UTMA features a tax bite the 529 does not: Dividends, capital gains and income above $2,200 (indexed for inflation) are subject to the “kiddie tax.” After that threshold, earnings are taxed at the higher rates applied to trusts and estates. 529s, on the other hand, feature tax-free growth. If you invest in your home state’s plan, there might also be a state tax deduction for your investment.
By the time Ciara went off to Ithaca College to major in journalism, the bulk of her college savings was in the 529. After she graduated in May of 2017 and landed a job as a reporter at a TV station in Savannah, Georgia, there was still money in the UTMA. That proved handy because of the flexibility of the UTMA.
“She had to relocate, and that’s where the UTMA came in,” explains Claybrook-Lucas. “We furnished her apartment, paid the security deposit, paid for her car, all from the money in the UTMA. We couldn’t have used the 529 money for that.”
Keep in mind that, because custodial accounts are considered the child’s asset, a UTMA could hurt you when applying for financial aid, as student assets carry more weight on the Free Application for Federal Student Aid (FAFSA).
Another negative: Once you make a gift into an UGMA/UTMA, it’s no longer your money. While your children are minors, you may use it for their benefit. But at the age of majority, it is theirs, and they can do what they want with the money. Think carefully about whether you’re comfortable giving up that kind of control to a young person who may or may not be financially responsible.