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Saving and investing for college expenses may seem overwhelming, but setting aside even small amounts can give your child a head start. While many people know about tax efficient investment accounts like 529 plans, they may not know about UGMA / UTMA accounts – another way to save on education and other expenses.
In this article, we're going to take a look at UGMA and UTMA custody accounts, what they are and how to find the best way to save for your children's future while getting tax benefits.
What are UGMA and UTMA accounts?
UGMA stands for the law on uniform gifts to minors and UTMA for the law on uniform transfers to minors. Account holders are "custodians" and can transfer money to the account to help the minor, but the money is managed by the custodian. As a rule, the money is released to the minor at the age of the majority (usually 21, but sometimes 18 or a different age).
How are UGMA and UTMA accounts different from 529 plans?
529 plans differ from the UGMA / UTMA account in a few key areas:
529 plans can only be used for educational spending, while UGMA / UTMA accounts can be used for anything that benefits the child. .
529 plans are owned and controlled by the person who created the account. With UTMA / UGMA accounts, the funds are transferred to the beneficiary at the age of the majority.
Unlike 529 plans, custody accounts are considered the property of the child, which means they make up a higher percentage when calculating the grant.
The two types of plans have some things in common:
Both types of accounts are considered custody accounts that can be used on behalf of a minor.
Anyone can contribute to either type of account – there are no limits on personal income
If you have a medium to long term horizon, either a UGMA / UTMA account or a 529 account is usually better than putting your money in a savings account at a low interest rate. And don't forget that it is possible to have both a 529 plan and a UGMA / UTMA account for the same child.
Why you need to open a UGMA / UTMA account for your children
Unlike a 529 plan, the funds in a deposit don't have to be used solely for college expenses. The custodian may withdraw money from a UGMA / UTMA deposit for any expenses that benefit the child, such as technology, transportation, housing or other expenses for the child.
The biggest advantage of UGMA / UTMA custody accounts is their flexibility. Because they can be used for a variety of expenses, even if your child chooses not to go to college, the money in the account can still be used. While revenue doesn't grow completely tax-free like in a 529 plan, revenue on a UGMA / UTMA account is tax-privileged, but in a different way.
Depending on how you file your tax return, a parent or guardian may include their child's unearned income on their own tax return. Unearned income is money that does not come from employment, such as interest or investments. In 2020, the first $ 1,100 of a child's unearned income is tax-free on the parent's tax return, and the next $ 1,100 is taxed at the child's tax rate, which is likely much lower than the parent's.
Things to look out for with UGMA or UTMA accounts
If you're looking to save money or transfer assets to your children for a wide variety of expenses beyond education, a UGMA / UTMA depository can make a lot of sense. One thing to look out for is that a UGMA / UTMA account is specifically tied to a named beneficiary. Unlike a 529 plan, which allows you to transfer the money in an account to a sibling or other beneficiary with a UGMA / UTMA account, unused funds must be used or distributed until the child is the majority or age has reached the maximum of its state age for custody accounts.
Apps like Acorns make it easy to open a UTMA / UGMA account with their new Acorns Early product. You can get started in less than a few minutes and schedule recurring investments from as little as $ 5 per day, week or month. Fun Fact: If you invest $ 5 a day from birth and factor in an average annual return on investment of 7%, you could have over $ 70,000 by the age of 18. Visit Acorns.com/Early for more information.
Dan Miller (38 posts)
Dan Miller is a freelance writer and founder of PointsWithACrew.com, a website that helps families travel for free / cheap. His home base is in Cincinnati, but he tries to travel the world as much as possible with his wife and 6 children.