How Financial Professionals can Help Clients Save for College: UGMA Accounts

Key Takeaways:

• Choosing to save for college through the Uniform Gifts to Minors Act (“UGMA”) or the Uniform Transfers to Minors Act (“UTMA”) may help your clients with children and grandchildren ease their worries about college education expenses.
• This type of custodial account can be set up on behalf of a designated minor beneficiary to use without limit when they reach adulthood.
• Contributions to an UGMA or UTMA account may be exempt from gift taxes up to $17,000 per year per contributor in 2023.
• Earnings are subject to income taxes, which may be at the child’s or parents’ rate, depending on the amount of income earned.
• Unlike college savings accounts like 529 plans and Coverdell ESAs, there is no penalty for using account assets for non-educational expenses.

As education costs continue to rise, saving for college can be a major concern for your clients with children. Uniform Gifts to Minors Act, or UGMA accounts are custodial accounts held in the name of a minor, created to make it easier for your clients to transfer money to minors without establishing a trust.¹ In addition to cash, these accounts can hold securities for the benefit of the child. Like 529 plans and Coverdell Education Savings Accounts, your clients may use these accounts to save for their child’s college education.

It’s important to note that accounts created under the Uniform Transfers to Minors Act (UTMA) may hold a broader array of asset types than UGMA accounts. While UGMA accounts are valid in all 50 states, UTMA accounts are not. Throughout this blog, we’ll use the term “UGMA,” but the discussion applies to UTMAs as well.

UGMA Accounts vs 529 plans vs Coverdell Education Savings Accounts

529 plans and Coverdell Education Savings Accounts (Coverdell ESAs) are tax advantaged accounts through which parents can save for a beneficiary’s college education. The major benefit of UGMA accounts in comparison to 529 plans and Coverdell ESAs is flexibility—the other plans are much stricter on how the beneficiary may spend the funds. 529 plans and Coverdell ESAs require the beneficiary to use the money for specified qualified education purchases, whereas UGMA account funds can be used for any of the beneficiary’s expenses. In general, UGMA accounts are attractive because they have no withdrawal penalties and no contribution limits.

UTMA vs UGMA Accounts

When referring to UGMA accounts to save for college, UTMA accounts may be brought up as well. Some people may use the names interchangeably, but there are slight differences between the two types of accounts. UTMA, or Uniform Transfers to Minors Act accounts allow gift transfers to minors outside of just cash and securities, and instead can include real estate, inheritances, and other physical property such as jewelry.² Your clients may use UTMA accounts to save for college if they are available in their state.

UGMA Account Rules

Your client’s beneficiary won’t be able to access the funds in their UGMA account until they reach adulthood, which depends on state law, but is typically 18-21.³ Once the minor reaches the specified age for their state, they’ll be able to access and manage their account. When the minor reaches the age of majority, they assume legal ownership of the assets in the UGMA account. While the child is a minor, the custodian may use funds in the account for the minor’s benefit.

The custodian has the authority to make investment decisions and withdraw funds from the account for the benefit of the minor, such as paying for educational expenses. Often, the child’s parent is the custodian, however, if a client makes gifts to the account and serves as custodian, the UGMA account funds will be included in the client’s taxable estate. UGMA accounts are irrevocable, which means that once the adult makes a gift to the account, they can’t take it back. The assets in the account belong to the minor, not the adult.

How Does a UGMA Account Affect Potential Financial Aid?

Like 529 plans and Coverdell ESAs, UGMA account money can impact the beneficiary’s ability to qualify for need-based aid. UGMA accounts are reported as a child’s asset, not the parents’.⁴ Need-based aid for schooling will typically more heavily consider the savings and investments a beneficiary has than those of his or her parents, but this can vary based on their specific circumstances. Generally, any assets will make it harder for a beneficiary to qualify for need-based aid, as there is technically less need.

UGMA Account Tax Information

UGMA accounts are not tax advantaged like 529 plans and Coverdell ESAs. While transfers in 2023 under $17,000 may be eligible for the gift tax annual exclusion, income taxes must be paid annually on the account’s income. From an income tax perspective, 529 plans and Coverdell ESAs may make more sense for clients, but clients may also consider an UGMA for expenses that 529 plans and Coverdell ESAs don’t cover.

Earnings on investments in an UGMA account are unearned income. While some unearned income will be taxed at the beneficiary’s rate, for 2023, a dependent’s unearned income over $2,500 will be taxed at the parents’ tax rate. Every client’s situation is different, so it’s best to consult a tax professional regarding your client’s specific situation with any questions that they may have.

Conclusion

UGMA and UTMA accounts can be a useful tool for parents, grandparents, and other loved ones looking to save money for a child’s future expenses. While they offer several benefits, it’s important for your clients to carefully consider the pros and cons before opening an UGMA or UTMA account. Based on their personal situation, a 529 plan, Coverdell ESA, or some combination of the three accounts may be the best option for your client.