UGMA vs UTMA: What's the Real Difference?

We all want to take care of our children financially, especially as they head to college or into the working world. You have many options. If a College 529 Savings Plan isn't ideal because you aren't sure if your child will go to college, you may consider a UGMA or UTMA account.

Before you do, know the differences between the UTMA vs UTMA account and how they compare to the 529 Plan so you choose the right option.

UGMA vs UTMA Overview

You often hear about UGMA and UTMA accounts together. They have many similarities since they are both custodial accounts, but they have differences and not just their names.

Most people know the UGMA or UTMA account as a college savings plan. It can be, but that's not all it can do. Many parents choose one of the two options as an investment account in lieu of a 529 Savings Plan, especially those who are leery about their child heading off to college.

Before we get further into it, let's define UGMA and UTMA.

UGMA stands for Uniform Gifts to Minors Act and UTMA stands for Uniform Transfer to Minors Act. The difference is in the name - one's a gift and one's a transfer, but how does that pan out for parents and children?

Read on to learn more.

How Do They Work?

First, let's clear the air. Neither UGMA nor UTMA accounts are strictly for college. Your child doesn't have to use any of the funds for post-secondary school if they choose not to go. They are a great alternative for parents who aren't sure of their child's intent after high school.

But, unlike the 529 College Savings Plan, even if you set up the account(s) for college and your child doesn't go, the money you put into the custodial account is your child's to use as he/she pleases. This can be good (you don't have to worry about tax liabilities if you use the money for other purposes), but also bad if your child can't be trusted with the funds.

Contributions

UGMA and UTMA accounts have no contribution limits or limit who can contribute. Parents, relatives, and friends may all contribute. The deposits, however, are irrevocable. Once you deposit them in the UGMA or UTMA, they are your child's assets that they can access between the age of 18 and 25.

All contributions are after-tax, which means no tax benefits (or deductions) for you or anyone contributing. There are some gift tax exclusions which we discuss below.

Accessing the Funds

Technically, all funds in the account belong to your child, but as his/her parent, you can withdraw funds for expenses that benefit your child. As long as the expenses are tied to your child, they are eligible expenses. You have control of the account until your child becomes a legal adult, usually age 18. As an adult, your child can decide how to use the funds.

Trust Like Treatment

UGMA and UTMA accounts are like a trust in one aspect - you assign a separate entity to hold onto the funds, letting them grow in your child's name.

Like an irrevocable trust, you can't change your mind and withdraw the funds. The only reason you can withdraw them is to cover an expense that benefits the beneficiary. But, it protects the funds from any third-parties like bill collectors or lawsuits.

Managing the Account

UGMA and UTMA accounts are custodial accounts. You, the parent, are responsible for the account until your child is a legal adult. All decisions you make about the account must be in the interest of the beneficiary.

Tax Treatment

UGMA and UTMA accounts aren't tax-sheltered. You contribute funds after taxes and pay taxes on the earnings too, but there are a few things to know:

Parents. relatives and friends may contribute up to $15,000 ($30,000 for a married couple) tax-free. Anything beyond this amount triggers a tax liability.
The first $1,050 in earnings is tax-free.
The next $1,050 in earnings is taxed at the 'kiddie tax rate' of 10%
Any earnings over $2,100 are taxed at the parent's tax rate

Main Differences Between UGMA vs UTMA

The main difference in UGMA vs UTMA besides the name is the assets allowed. UGMA originated first and has been around since 1956, but has tighter restrictions. You can invest in stocks, bonds, and mutual funds - the assets most people invest in for retirement.

The UTMA, which started in 1996, allows more assets including physical assets, such as real estate, art, and cars.

Another key difference is the age your child gets custody of the funds. The UGMA automatically transfers to your child's custody when they turn 18 years old. The UTMA offers more options. In many states, you can choose an age between 18 and 25, which may help parents of children who aren't mature enough to receive a large sum of money if not going to college.

UGMA and UTMA vs College 529 Savings Plan

UGMA, UTMA, and College 529 Savings Plans all save for the future of your child. There are major differences, though.

Parents retain control over a 529 Plan for life. The child never takes custody of it, and parents can use the funds for expenses other than college but will pay tax consequences.
Money used for college or other educational purposes incurs no tax liability even on the earnings.
Some states offer tax deductions for a 529 Plan.
529 Plans have specific (and limited) investment options

The largest difference is the tax treatment and who controls the account. UGMA and UTMA proceeds always incur taxes in the year you have the earnings. You may never pay taxes on 529 earnings if you use them for educational expenses.

Pros and Cons of UGMA and UTMA Accounts

Pros

Your child can use the funds for any purpose, not just college. Not every child goes to college.
Earnings grow at a lower tax rate until they exceed $2,100 annually.
Creditors can't come after the assets.
Anyone can open a UGMA or UTMA account, there aren't any income limitations.
A wider selection of investment options than most 529 Plans.

Cons

The earnings may trigger a tax liability each year.
The deposits are irrevocable.
Withdrawals may only be made if they benefit your child.
Your child has complete rights to the account upon the stated age (usually between 18-25)

Financial Aid and UGMA and UTMA Accounts

If you're thinking about a UGMA or UTMA account for college, think again. The FAFSA Application considers UGMA and UTMA assets your child's assets, so they count the assets at a rate of 20% versus 5.64%, which is the parental rate. This means you'll receive less financial aid and have to pay more out of pocket for college.

UGMA vs UTMA: The Bottom Line

Choose the custodial account for your child's future carefully. If you know your child will go to college, look at all options and compare the bottom line. Make sure you're getting the full tax advantages saving for your child's education.

If you'd rather have more flexible use of the funds and aren't as worried about the tax liability, look at your options regarding UGMA vs UTMA. If you have other assets you want to include for your child, the UTMA has more flexibility, but if you're a traditional investor the UGMA may suffice.

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