Is a UTMA Account Right for You?

hn5ytnkwuxw-markus-spiske-1Uniform Transfer to Minors Act or UTMAs offer parents, grandparents and others a tax efficient, flexible way to make financial gifts to their kids or grandkids. Like most investments there are pros and cons.

Before you open or add to a UTMA account for your kids or grandkids there are some things you will want to consider.

UTMA Accounts aren’t for everyone. Specifically, they are for minors. Uniform Transfer to Minor Accounts were created by the Uniform Transfer to Minors Act (or Uniform Gift to Minors Act depending on your state). Since minors are unable to own securities like stocks, bonds and mutual funds, UTMAs provide a vehicle for them to hold these assets with the fiduciary oversight of a custodian – usually Mom, Dad or a grandparent.

UTMA Accounts can be tax efficient, but they’re not necessarily tax-free. The first $1,050 of unearned income in a UTMA account is 100% tax-free. The next $1,050 is taxed at the child’s tax rate, which is typically quite low. Any unearned income that exceeds $2,100 is then taxed at the parent’s rate, which can be as high as 39.6%.

UTMA Accounts have greater investment flexibility. UTMA accounts can be invested with fewer limitations than other types of savings plans that are typically used for kids. Most stocks, bonds, mutual funds, index funds and other traditional investments, for example, are allowed.

A custodian may also trade as frequently as she likes. Unlike some types of college savings accounts that allow only two changes to the asset allocation in a calendar year, UTMA accounts can be reallocated without these restrictions.

Distributions from UTMA accounts can be used for any purpose. The law requires that money in a UTMA be used for the best interest of the minor. Generally this is considered to be things beyond the usual food, clothing, and shelter that a young person would require, but the law doesn’t say specifically what those expenses are. That leaves a lot of options: College expenses not covered by other savings plans? Of course. Music lessons? Perfectly acceptable. Hotel and travel expenses for the high school band trip to Europe? Definitely.

UTMA Accounts may reduce your ability to receive financial aid for college. A UTMA account is considered a student asset on the FAFSA and CSS Profile college financial aid forms. For parents who expect to receive need-based financial aid such as Pell Grants or even institutional need-based financial aid, a UTMA account will likely reduce the amount of college financial aid that you may qualify for. Keep this in mind before gifting large sums to a UTMA.

No contribution limits or deadlines. Most investments that offer a tax or other specific benefits have limits on the amount that can be contributed and deadlines when contributions can be made. UTMA accounts have no contribution limits or deadlines. Parents can fund these accounts with as much money as they like and at any time of the year.

However, there are two big drawbacks that apply to all UTMA accounts:

A gift to a UTMA is irrevocable. Some savings plans allow parents to change beneficiaries or make other changes to the ownership of those accounts. With UTMA accounts the money in that account legally belongs to minor named on the account and is considered to be an irrevocable gift. Parents may not use these assets for the benefit of anyone other than the minor named on the account.

Control of a UTMA transfers to the minor at age 21. When a minor reaches the age of majority, 21 in most states, he or she will take legal control of the UTMA. As the account owner they are free to use that money as they wish. They don’t have to use it for college. They don’t have to save it for retirement. They can do anything they want with that money.

Uniform Transfer to Minors Accounts can be an excellent way to set aside money for your children’s benefit later in life, but as with most investments there are pros and cons. Consult your tax advisor or financial professional to determine if a UTMA may be right for you.