UTMA vs. UGMA Accounts

If you want to transfer some of your assets to a minor, an UTMA account could be a suitable option. These accounts have certain advantages, but it's important to understand how they work and how they're taxed before making a decision. Below, you can find out what an UTMA account is and whether it's the right choice for you.

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What Is an UTMA Account?

An UTMA account is a custodial account used to hold assets for minors. Generally, you can't transfer assets directly to a minor child. However, the Uniform Transfers to Minors Act (UTMA) resolves this issue by permitting adults to pass on assets via a custodial account. 

Children can't manage or access the funds in their UTMA account until they reach a certain age — usually 18 or 21. Until then, a responsible adult known as a custodian looks after the account until the child can legally manage it themselves. 

There are various reasons you might wish to open an UTMA account for a minor. For example, many parents transfer money into an UTMA account to fund their child's college education. Alternatively, you can use an UTMA account as part of your estate planning to leave funds or an inheritance to minors. 

UTMA accounts aren't the only option if you want to transfer some of your assets to a minor. Setting up a trust is an alternative to a UTMA account, although it's often more expensive. You could also consider starting a 529 college savings plan if your main aim is to fund the beneficiary's education.

How Do UTMA Accounts Work?

Setting up an UTMA  through a bank or brokerage is relatively straightforward, but it's worth shopping around to find an option that meets your needs. For example, some institutions charge account fees or set minimum deposits, so it's essential to check any account you choose is affordable.

Once you've opened the account on behalf of the beneficiary, you can deposit assets. Many people deposit money, but you can also use an UTMA account to hold other assets such as real estate, art or jewelry. 

You can act as the custodian of the account or choose another trusted person or financial institution to carry out the role. The custodian will then manage any investments on behalf of the beneficiary until they come of age. They may also withdraw and spend funds, providing it's in the minor's best interests. For example, custodians are usually authorized to spend UTMA funds on the child's education. However, you can't use UTMA funds to finance basic living expenses such as food and accommodation.

What's the Difference Between UTMA and UGMA Accounts?

UGMA accounts are a type of custodial account similar to an UTMA account. UGMA stands for the Uniform Gift to Minors act and is an earlier version of the more recent UTMA act. All 50 states recognize UGMA accounts, while South Carolina and Vermont are the only states not to adopt the UTMA act. 

The primary difference between an UGMA and UTMA account is that the age of majority varies depending on what state you live in. For example, account beneficiaries in Massachusetts can independently access funds in an UGMA account at 18 years old, but must wait until they are 21 to access an UTMA account. Often, the age of majority is lower for an UGMA account than an UTMA account, but this isn't always the case.  

What Happens to an UTMA Account When the Child Turns 18?

Whether a minor can access and manage their UTMA account when they turn 18 depends on the rules in their state, and the age of majority for an UTMA account doesn't necessarily correspond with the age of legal adulthood. Once the person reaches the age of majority, they assume full control of the account. 

Some states allow custodians to delay the account transfer to a limited degree. For example, the state may allow the beneficiary full control over their UTMA account at age 18 with their custodian's permission. Otherwise, the beneficiary must wait until they are 21, when the account is automatically transferred. Other states allow the custodian to retain control of the account until the beneficiary is 25. 

Do I Have to Pay Taxes on an UTMA Account?

UTMA accounts are exempt from gift tax if the account contributions are less than $16,000. Any contributions exceeding this amount are subject to gift tax, and paying gift tax is the donor's responsibility. 

Following the Tax Reform Act of 1986, unearned income from sources such as UTMA accounts is taxed at the parent's income tax rate over a certain threshold. This is known as the 'kiddie tax' and prevents parents from avoiding paying income tax by transferring assets to their children to take advantage of their lower tax rate. 

As of 2022, the first $1,150 of a minor's unearned income counts as the standard deduction, which means it isn't taxable. You'll pay the child's income tax rate on the next $1,150. Any contributions exceeding $2,300 are taxed at the parent's tax rate. 

Transferring assets to your child via an UTMA account can also have implications on your estate tax rate. Therefore, it's worth consulting a tax advisor before setting up a custodial account. 

What Are the Advantages and Disadvantages of UTMA Accounts?

One of the primary advantages of transferring assets via an UTMA account is that it offers flexibility on how the money is spent. For example, an UTMA account could be a better option if you are unsure whether your child will attend college, as funds deposited in accounts like a 529 college savings plan must be spent on education. The $16,000 gift tax exemption can also make an UTMA account the most cost-effective solution in some cases. 

However, there are also drawbacks to UTMA accounts. You can't change your mind once you transfer assets into an UTMA account, and it can affect your child's entitlement to financial age when they enroll in college. Furthermore, you'll lose control of how the beneficiary spends the money after they reach the age of majority. 

Overall, an UTMA account can be a good option if you want to transfer small amounts that don't exceed the standard deduction or you intend to spend the money for the beneficiary's benefit before they reach the age of majority. However, opening a trust or college savings account could be more suitable if you want to earmark the funds for the beneficiary's education or have more of a say in how they spend the money.