The Uniform Gift to Minors Act (UGMA) is a versatile tool that offers a way for parents, grandparents and guardians to invest on behalf of a child or grandchild.1 But what is a UGMA account, how does it work and how does it compare to other college savings accounts?
This guide to UGMA accounts explains how they work, outlines the advantages and considerations and reviews the potential opportunities they may provide.
UGMA Account Defined
Established under the 1956 Uniform Gift to Minors Act, these accounts provide a legal framework for making financial gifts to minors. A custodial account allows individuals to transfer assets to a minor without setting up a trust. Often used for investments, they offer a straightforward way to grow and manage assets for a child’s benefit.
How Does a UGMA Work?
As a custodial account, a UGMA account allows parents, grandparents or guardians to transfer assets to a minor. The goal is to invest assets in a child's name until the child takes control of the account at the age of majority. To understand how these accounts work, it helps to review the account structure, permissible assets and age of majority.
Account Structure
A UGMA account is typically opened by a custodian, often a parent, grandparent or another relative. The custodian manages the account on behalf of the minor until the child reaches the age of majority, usually 18 or 21 depending on the state.
Permissible Assets
UTMA accounts can hold a wide range of assets, including cash, stocks, bonds, mutual funds, and other securities. Depending on state law, they may also allow assets such as real estate or other property. UGMA accounts are more limited and generally allow only cash and securities, not real estate.
Tax Implications
Contributions to a UGMA account are made with after-tax dollars, and earnings generated within the account are subject to taxation. The first $1,350 of a minor child’s unearned income is generally tax-free. The next $1,350 is taxed at the child’s tax rate. Amounts over $2,600 are taxed at the parent’s tax rate.
Age of Majority
A defining feature of a UGMA account is that control automatically transfers to the minor when the child reaches the age of majority. At that point, the child has full control over the assets and can use them for any purpose, including education, a major purchase, starting a business or other needs.
Pros & Cons of UGMA Accounts
UGMA accounts offer tax advantages and can support estate planning goals. However, there are trade-offs to consider, including loss of control and potential tax and financial aid impacts.
Pros of UGMA Accounts
- Tax Efficiency: The first $1,350 of unearned income is tax-free. The next $1,350 is taxed at the child’s rate (any unearned income above that amount is generally taxed at the parents’ rate under kiddie tax rules).
- Flexible Use of Funds: At age 18 or 21, depending on the state, the child gains full control of the assets. The funds can be used for any purpose.
- Estate Planning Tool: UGMA accounts allow assets to transfer to the next generation while the custodian maintains control until the child reaches the age of majority.
- Financial Education: Managing the account can help a child learn about investing, budgeting, and wealth management.
Cons of UGMA Accounts
- Loss of Control: Once the child reaches the age of majority, the custodian no longer controls the account. The child can use the funds without restrictions.
- Tax Implications: Earnings are subject to taxes. The kiddie tax may apply, which can tax a child’s unearned income at the parent’s higher rate.
- Financial Aid Impact: UGMA assets are counted when determining financial aid eligibility for higher education.
- Investment Complexity: UGMAs aren’t inherently complex. They’re simply accounts that hold investments for a minor. The custodian chooses and manages those investments and must act in the child’s best interest until they reach the age of majority.
UGMA vs. Other College Savings Plans
A UGMA account can help you invest for a minor, but it is not the only option. Other accounts to consider include:
- Uniform Transfers to Minors Act (UTMA) account
- 529 savings plan
- Coverdell education savings account (ESA)
Below is a side-by-side comparison to help clarify the differences of other college savings plans.
UGMA vs. UTMA
UGMA and UTMA accounts are both custodial accounts created for a minor’s benefit. A custodian manages the account until the child reaches adulthood. Key differences are outlined below.
Key Differences
| Feature | UGMA | UTMA |
|---|---|---|
| Permitted Assets | Cash, stocks, bonds, mutual funds | Financial assets plus real estate, artwork, and other tangible property |
| Legal Structure | Simpler and generally easier to manage | May be more complex if holding property |
Similarities
Both UGMA and UTMA accounts are managed by a custodian until the child reaches adulthood. Contributions are not tax-deductible. Earnings are taxed at the child’s rate, and the first $1,350 of earnings is generally tax-free. Principal withdrawals are tax-free.
How To Choose
Choose either account if you plan to invest only in financial assets. If you want to hold real estate or other tangible property, you need a UTMA account. Also review state rules if you may move or if beneficiaries live in different states. For legal or tax questions about specific assets, speak with a qualified professional.
Your decision will depend on the types of assets you want to transfer and manage for the child.
UGMA vs. 529 Savings Plan
A UGMA account and a 529 savings plan serve different purposes. Your choice depends on whether your goal is flexible investing or education-focused savings.
Comparison Overview
| Feature | UGMA | 529 Plan |
|---|---|---|
| Primary Purpose | General investing for a minor | Education expenses |
| Contributions | No tax deduction; annual gift tax exclusion apply | State tax deduction possible; gift tax limits apply |
| Earnings | First $1,350 tax-free; excess may be taxed at parents’ rate | Tax-free if used for qualified education expenses |
| Distributions | Available at adulthood for any use | Tax-free for qualified expenses; taxes and penalties on nonqualified withdrawals |
| Investment Options | Broad investment choices | Limited to plan options |
| Financial Aid Impact | May reduce need-based aid | More favorable financial aid treatment |
| Control | Custodian manages until adulthood | The account owner retains full control |
How To Choose
You might consider a UGMA account if you want flexibility and do not plan to limit funds to education expenses. A 529 plan may be a better choice if your main goal is to pay for education and benefit from tax-free growth on qualified expenses. Before selecting a 529 plan, review your state’s tax benefits and compare the investment options.
Your choice should align with how you plan to use the funds and how important education tax benefits are to you.
UGMA vs. Coverdell ESA
Both accounts allow you to invest for a child’s future, but they operate under different rules.2
Comparison Overview
| Feature | UGMA | Coverdell ESA |
|---|---|---|
| Primary Purpose | General investing | Education expenses with tax benefits |
| Contribution Limits | Annual gift tax limits apply | $2,000 per year; income limits apply |
| Tax Deduction | None | None |
| Earnings | Taxed at child’s rate | Earnings grow tax deferred; withdrawals may be tax free |
| Distribution Rules | Available at adulthood for any use | Tax-free for qualified expenses; taxes and penalties on nonqualified withdrawals |
| Age Limits | No age limit, but contributions must be for a minor | Contributions before age 18; generally used by age 30 |
| Financial Aid Impact | May reduce need-based aid | More favorable than UGMA |
| Investment Options | Broad choices | More limited options |
How To Choose
You may prefer a UGMA account if you want flexibility and do not plan to limit the funds to education expenses. A Coverdell ESA may make more sense if your goal is to pay for education costs and benefit from generally tax-free qualified withdrawals. Your decision should reflect how you plan to use the funds and the child’s age.
Each account has advantages and trade-offs. Your decision should reflect how you intend to use the funds and the child’s age.
Choose the college savings plan that works best for your needs. Invest In My Child3
When to Use UGMA for Your Child
A UGMA investment account can help you set aside money for a child’s future. Before opening one, think about your goals and how the account works. A UGMA can support education costs, major milestones, or business ideas. As with any investment, your approach should match your goals and circumstances.
Setting Up the Account
- Open the Account Early: Starting sooner allows more time for potential growth.
- Define Your Goals: Consider why you want to set money aside. You may want the funds to help cover:
- Education expenses
- A major purchase, such as a car
- A head start in early adulthood
With a UGMA or UTMA, you cannot legally control how the money is used once the child reaches the age of majority. Unlike a trust, these accounts do not allow rules or conditions. The assets become the child’s property, and they can use the funds at their discretion.
- Choose a Custodian: The custodian is usually a parent, grandparent, or legal guardian. This person manages the account until the child reaches the age of majority.
- Select Investments Carefully: Build a diversified strategy based on:
- The child’s time horizon
- Risk tolerance
- Your goals for growth and principal preservation
Accessing & Using the Funds
Transfer of Control: The child gains control of the account at the age of majority, which is typically 18 or 21 depending on the state. This can be a good time to teach money management skills.
Qualified Uses: Funds must be used for the child’s benefit and cannot cover expenses that are considered parental obligations.
| Allowed Uses | Not Allowed Uses |
|---|---|
| Education costs | Food |
| Approved expenses that benefit the child | Housing |
| Other non-obligatory expenses | Clothing |
Parents are responsible for basic living expenses, so UGMA funds cannot be used for those costs.
Examples of How Funds May Be Used
UGMA funds can help pay for college tuition and related expenses. They may also cover education or training outside a traditional college.
If the child wants to start a small business, the funds can help with start-up costs. They can also be used to build an emergency fund, encouraging smart money habits and a strong start to adult life. This may help the child plan, save, and prepare for major purchases, such as a first home.
Is UGMA Right for You?
A UGMA account can be a flexible way to invest for a child while keeping management simple during their early years. It offers broad investment choices and estate planning benefits, but it also requires giving up control once the child reaches adulthood. Before opening an account, weigh your goals, tax considerations and how you want the funds to be used in the future.
UGMA accounts can offer a streamlined way to save for your child’s education goals. Invest In My Child3
Sources
- SI SF01120.205 Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) – Age of Majority (TN 1 - 02/2008). https://secure.ssa.gov/poms.nsf/lnx/0501120205SF.
- Topic no. 310, Coverdell education savings accounts. https://www.irs.gov/taxtopics/tc310.
- Fabric by Gerber Life. UGMA investment accounts for kids. https://meetfabric.com/ugma-investment-account-for-kids?utm_source=wsfg&utm_medium=site&utm_campaign=ugma&utm_content=ugma-account.
