Senior Wealth Planning Strategist

In this Wealth Planning Update:

  • UTMAs 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 regret, 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 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 custodian for the gifted/transferred assets for the beneficiary. Testamentary documents (e.g., wills, trusts) may also allow a trustee to distribute funds for a beneficiary under the age of majority. Other donors use annual exclusion gifts (currently up to $14,000 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:

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' rate) may apply. Earnings can potentially grow tax-deferred. Qualified withdrawals are exempt from federal taxes.
Who controls the account? Custodian (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. Withdrawals must be used for qualified higher education expenses or else earnings are subject to a 10% penalty plus taxes.
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.

Some families choose to save for all or a portion of child's college education with UTMAs. UTMAs allow for a broader choice of investment options because they can be set up using brokerage or investment accounts, as opposed to other college savings, such as 529 plans, which have limited investment selections (usually limited to mutual funds, selected by the 529 plan provider).

Before termination age, 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.
  • 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 regret?

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. One of the easiest ways to keep the UTMA assets out of the child's hands is to spend it for his/her benefit when they are young for expenses incurred over and above normal expenses, such as for a special camp, a laptop, a car, or other expenses.

You can also ask your attorney about funding a trust with the UTMA account. In some circumstances, it may be an appropriate option. Factors to be addressed with your attorney include present interest issues and the need to maintain the rights to the assets at the age of majority, including a full right of withdrawal that expire in a 30 or 60 day period. Another avenue worth considering is establishing a conditional revocable trust after the child has reached the age of majority.

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.