Students at graduation

Key takeaways:

  • Uniform Transfer to Minors Act (UTMA) accounts may help supplement college savings or be an important part of a parent’s gifting strategy.
  • UTMA accounts can help parents transfer assets to their kids in a protected manner, but unlike a 529 plan, the money has fewer restrictions associated with its use.
  • Before setting up an UTMA, be clear about the purpose and amount that is appropriate.
  • If you’ve set up an UTMA and have regrets, there may be ways to mitigate the impact on your child.

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Many parents want to assist their children (and grandchildren) with college tuition payments. Some parents start thinking about it even before their first child is born; others may address it later once they have addressed other goals, such as home ownership. 

There are various ways to help finance a college education. For many years, the primary choice was to use the Uniform Gifts to Minors Act (UGMA). This enabled individuals to transfer funds to their children in a legal manner without having to establish and administer a formal trust or obtain guardianship or conservatorship. This act was succeeded by the Uniform Transfer to Minors Act (UTMA), which expanded UGMA law to include ownership in other types of property. In 1996 another option designed specifically for college savings, 529 plan accounts, became available. Because of the available choices, parents now need to determine which alternative is best suited for their situation. This Wealth Planning Update outlines the differences between UTMAs and 529 plans. 

Why do people set up UTMAs?

There are many reasons to set up an UTMA account for a minor child. Mainly, the UTMA account provides oversight and guidance by the trustee for the gifted/transferred assets for the beneficiary. Testamentary documents (e.g., wills, trusts) may also account for UTMAs to be funded for a beneficiary under the age of majority in the decedent’s state of residence. Other donors use annual exclusion gifts (currently up to $15,000 per individual) with an UTMA to fund a savings vehicle for college or other reasons without having to execute a formal trust. But it’s important to understand the tax and other considerations of UTMA accounts. 

Many think about UTMAs for funding education. However, as noted above, UTMAs, unlike 529 plans, are not for a singular purpose. Once the beneficiary gains control of the assets, he or she can use them however he or she sees fit. Here is a comparison of the two types of accounts :

UGMA/UTMA 529 College Savings Plan
How much can be contributed? Unlimited contributions (subject to gift tax rules) Limits vary by state
What are the income tax implications? A portion of earnings are exempt, and a portion may be taxed at the child’s rate. The Kiddie Tax (using the parents’ marginal tax rates) may apply. Earnings can potentially grow tax-deferred. Qualified withdrawals are exempt from federal taxes.
Who controls the account? Trustee (fiduciary duty to invest the account appropriately) controls until custodianship ends (depends on state in which gift was made), at which time the child assumes control. Account owner (usually the donor)
What are the gift tax and estate tax impacts? Contributions are considered completed gifts. If the donor is the custodian and dies prior to the child’s age of majority, the account may be included in the donor’s taxable estate. Contributions are considered completed gifts. If the donor dies before the funds are used, the assets are not included in the donor’s taxable estate. The donor can contribute as much as five times the current annual exclusion in one year without triggering gift taxes.  However if the donor passes before the five year period has ended, the portion allocated to the years after the donor’s death will be included in the donor’s estate.
Are there restrictions? Withdrawals can be used for higher education or non-educational needs of the child.  Note that distributions used for expenses that are the legal obligation of the beneficiary’s parent (food, clothing and shelter) may be deemed taxable income to the parent. Withdrawals can be used for higher education or non-educational needs of the child.  Note that distributions used for expenses that are the legal obligation of the beneficiary’s parent (food, clothing and shelter) may be deemed taxable income to the parent.

Withdrawals must be used for qualified higher education expenses, including qualified apprenticeship programs, or else earnings are subject to a 10% penalty plus taxes. 

Plan distributions may be used for qualified education loan repayments; there is an aggregate lifetime limit of $10,000 per plan beneficiary and $10,000 per each of a plan beneficiary’s siblings.  

Up to $10,000 per year may be used for tuition cost per student at a public, private or religious elementary or secondary school.

Is there an impact on financial aid? May reduce financial aid. May be included for financial aid depending on whether the owner is a custodial or non-custodial parent, grandparent or other individual.  Distributions may count as income for financial aid depending on the owner.
Can you change beneficiary? No, the gift is irrevocable. Yes, there are no tax consequences if the new beneficiary and the old beneficiary are qualified family members and are assigned to the same generation for generation skipping transfer tax purposes.

Some families choose to save for all or a portion of child’s college education with UTMAs. UTMAs allow for a greater level of flexibility when it comes to investment options because they can be set up using “self-directed” brokerage or investment accounts, as opposed to other college savings, such as 529 plans, which have limited investment selections (usually limited to a handful of mutual funds, generally selected by the 529 plan provider).

Please consider the investment objectives, risks, charges and expenses carefully before investing in a 529 savings plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest.

Before the age of majority is attained, the UTMA donor should consider:

  • Periodically reviewing the investments with your advisor in order to understand the asset allocation and taxation of each asset.
  • Using the UTMA as a tool to help educate and financially mentor the beneficiary. Be candid and discuss how you came into wealth and the steps you’re taking to help preserve it. You can also discuss your intentions for the funds and your values with respect to money.
  • Being careful not to overfund the UTMA account. Devise a plan for what the funds are for and how much your child/beneficiary will need for that purpose, factoring in appreciation and inflation.  
  • Marrying UTMAs with other savings vehicles, such as 529 plan accounts and Crummey trusts.
  • Reviewing your estate planning documents and understanding the potential impact of relying on UTMA accounts vs. trusts in the event that you predecease a minor beneficiary. Discuss with your attorney whether UTMA provisions in your estate plan will provide the level of protection for your minor beneficiaries you desire.

What do you do if you’ve overfunded an UTMA and have regrets?

When using an UTMA account for education, it is not unusual for the parents or grandparents to overfund their beneficiaries’ accounts. This may be problematic as the donor may worry about the impact of the UTMA assets on the donee. Will it demotivate them? Will they spend it frivolously? Whatever the reason, if you feel that the beneficiary of the UTMA is not ready to take control, you should discuss it with your financial and tax advisors as there may be a possible solution.  

Regardless of your actions, it is important to keep in mind the UTMA is to be used solely for the benefit of its intended beneficiary. With this in mind, the trustee can spend the UTMA down for expenses incurred over and above normal expenses, such as for a special camp, a laptop, a car, or other expenses. If you want to preserve the assets but do not want the child to have access to them, you can transfer the funds into several different vehicles, such as a 529 plan, provided the plan will accept the UTMA funds (there are also a number of rules that apply, so you should seek advice). 

You can also ask your attorney about funding a trust with the UTMA account. As long as you are still the custodian and the terms of the trust are for the sole benefit of the child, this may be an appropriate way to continue to have restrictions around the funds. Lastly, if the child has earned income, you can fund a Roth IRA with contributions from the UTMA in the lesser of the amount of earned income or the contribution limit for that year. An additional benefit of the Roth strategy is that retirement assets are not likely counted for financial aid purposes.

You may consider changing the investment focus and/or asset allocation of the UTMA before it transfers to the control of the child. For example, you may be able to invest in more illiquid investments or forced savings vehicles, like an immediate annuity based on the child’s life expectancy.

As the custodian or trustee of an UGMA/UTMA, consider seeking advice from a knowledgeable advisor on best practices for creating, funding, on-going administration, and transferring of an UTMA. You have a fiduciary responsibility to act in the best interests of the beneficiary; failing to do so may result in legal concerns. Not to mention, you will have missed an opportunity to educate and mentor the beneficiary and help him or her take that first step on the road to financial success.