What if you could teach your kids about investing with a real-life, real-time investment instrument? That’s what Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) accounts are. As you can imagine, we love to educate our kids about money. So, for that reason, we find UGMA and UTMA accounts fascinating. To be crystal clear, this is investing in stocks, bonds, etc., with all the risks associated with any such investments. So these plans are not everyone’s cup of tea. But as a teaching tool and potential pool of money for your kids’ college and adulthood planning, they are pretty cool.
UGMA/UTMA are custodial accounts used to hold and protect assets for minors until they reach the age of majority in the state in which they live. These accounts typically allow stock, bond, and mutual fund investments, but not higher-risk investments like stock options or buying on margin. Some people enjoy helping their kids pick out stocks, so this account type is a good way to go for that kind of educational purpose.
Here are some basics you need to know:
- Taxes up to a certain amount will be assessed at the child’s tax rate rather than the parents’ rate. This is not a tax-deferred option, but tax liability is less than it would be for assets taxed at the rate adult income-producers would be taxed at.
- The same tax benefit that makes custodial accounts attractive can also make them unattractive. Above a certain level of income produced by these accounts, the excess income is taxed at the parents’ marginal tax bracket. You’ll want to explore the details of this with your tax professional.
- Be aware that these custodial accounts are considered an asset of the child and because of that, are counted against financial aid. If college is part of the plan for these funds, around 20% of these assets should go towards funding a student’s education in any given year.
If you are someone who has a more hands-on approach with your own investing, UGMA/UTMA might be a great option for you. Many people like picking stocks for their kids and/or with their children. This account registration is great for that. In contrast to 529s, which are a more “fix it and forget it” approach that precludes you from buying stocks individually, UGMA/UTMAs are the anti-529.
Another reason we like UGMA/UTMAs is they are truly a College and Adulthood Planning account. At the age of majority, it moves from being a custodial account to full ownership by your child. This individual brokerage account can then be used for school, cars, home, travel, to start a business, or building an account from there with after-tax funds. The account could also be shifted to generate income and start generating passive income for your student or young adult.
For people who are more entrepreneurial, UGMA/UTMA accounts are a great way to bond with your kids and help them understand the adult responsibility that comes with managing money.