UTMA & UGMA Accounts: How They Work, How to Set One Up

As a parent or guardian, planning for your child’s needs is top of mind. A lot of times, this leads to a conversation about saving for college, but focusing solely on saving for future education expenses might not be the best fit for every child. Enter the UTMA or UGMA account, also known as the custodial account.

» Learn more: The best types of investment accounts for kids.

What is a UGMA or UTMA account?

UTMA and UGMA accounts are taxable investment accounts set up to benefit a minor but controlled by an adult custodian (parent, guardian, relative, etc.) until the minor reaches the age of majority — when a minor is legally considered an adult, which differs by state. At that point, the account assets transfer into the minor's name, and they take over from there.

Although the custodian of these accounts invests and manages the account, only the minor can use or benefit from it — the account and assets within are irrevocable and considered property of the minor. This means that the minor is also responsible for paying taxes on any investment income earned. Usually, the first $1,300 of income is free from tax, but at income above those levels, taxes might be owed at either the child's or guardian's tax rate. (Learn more about how the kiddie tax works.)

» Ready to jump in? Check out our list of the best custodial accounts.

UGMA vs. UTMA: What's the difference?

The acronyms hail from the state laws that put these accounts in place — the Uniform Transfer to Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA).

• UGMA came first and is valid in all 50 U.S. states. It allows gifts of cash or securities to be given to minors without tax implications up to gift tax limits.

• UTMA came after and expanded gifts to include property and other transfers for those states that have adopted it (all U.S. states except South Carolina and Vermont).

Why use a UGMA or UTMA account?

Not everyone ends up attending college. Perhaps a child is better suited for an apprenticeship or to take over the family business. Or, you may want the child to take out a loan and be responsible for covering the cost of their educational expenses. The UTMA or UGMA account helps a minor save and invest while providing flexibility.

Another perk of UTMA and UGMA accounts is sidestepping the need to set up a trust when giving assets to and managing assets for your child or another minor. The custodian handles and invests the account assets in the best interest of the beneficiary without needing to hire an estate-planning attorney or draw up legal documents.

Other UTMA/UGMA considerations

Once the child turns the age of majority, the account assets are theirs. Depending upon the amount of assets and the child, this could be a significant financial responsibility to take on. Even if your intention was for the money to go toward education, nothing prevents the child from purchasing their first motorcycle and riding off into the sunset instead. In contrast, a trust can provide more control and rein in undesirable spending.

Since the account assets are considered theirs, UTMA and UGMA accounts are reported as such when it comes to applying for college financial aid. The child’s eligibility for aid will be reduced by 20% of their UTMA or UGMA account asset value. In comparison, 529s and Coverdells reduce aid by only up to 5.64% of the asset value because these plans are considered property of the account owner.

But if education isn’t your key concern, UTMA and UGMA accounts have fewer restrictions and can provide you and the child with more options when saving and investing for their future.

Which custodial account is right for you?

If saving for education is a key goal, comparing UTMA or UGMA accounts with 529s or Coverdell education savings accounts (ESAs) can help you narrow down the best option for your family situation.

According to IRS rules, both 529s and Coverdell ESAs are meant to be used for qualified educational expenses (tuition, books, etc.). If not, withdrawals are subject to a 10% federal penalty. There are no use requirements for withdrawals from UTMA and UGMA accounts.

Additionally, 529s and Coverdell ESAs are subject to contribution limits. There are no annual contribution limits for 529s, but there are aggregate contribution limits to be aware of. Coverdells have annual contribution limits and income-based eligibility restrictions. UTMA and UGMA accounts do not have any limitations on contributions.

However, 529s and Coverdell ESAs provide tax-advantaged growth, whereas UTMA and UGMA contributions are taxable accounts. With 529s, the beneficiary can be changed to another if the current beneficiary doesn’t need the money, which is not possible with UTMA and UGMA accounts.

Parents of children with disabilities might want to invest to make sure their children are taken care of financially. ABLE accounts are tax-free savings vehicles that can be an effective option to consider.

How to get started with a UGMA or UTMA account

If you’re ready to get started with a UTMA or UGMA account, we’ve outlined the process of opening a custodial account and answered some frequently asked questions.