UGMA Custodial Accounts: What You Need to Know

Preparing for your child or grandchild’s future can feel like an overwhelming task, especially when it comes to managing finances. That’s where UGMA custodial accounts can help. These accounts provide a structured, flexible, and tax-advantageous way to save for a minor’s future expenses.

Whether you’re a parent exploring investment options or a financial planner advising a client, understanding the ins and outs of UGMA (Uniform Gifts to Minors Act) custodial accounts is key to making informed decisions. This blog will walk you through everything you need to know—from their purpose to the benefits and considerations they bring.

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What Are UGMA Custodial Accounts?

UGMA custodial accounts are financial accounts created under the Uniform Gifts to Minors Act, which allows minors to own assets before they reach the age of legal adulthood (typically 18 or 21, depending on the state). These accounts are overseen by a custodian—usually a parent, grandparent, or guardian—who manages the assets until the child reaches the age of majority.

Unlike traditional savings accounts, UGMA accounts can hold a wider variety of assets, including cash, stocks, bonds, mutual funds, and other securities. However, they do not support real estate investments.

How UGMA Accounts Differ from Similar Accounts

UGMA accounts are often grouped with UTMA (Uniform Transfers to Minors Act) accounts, but there’s a key difference. While UGMA accounts are limited to financial assets like stocks and bonds, UTMA accounts can also include real estate, fine art, and other tangible property. Deciding between UGMA and UTMA often depends on the types of assets you wish to invest in for a minor.

Benefits of UGMA Custodial Accounts

UGMA custodial accounts are an excellent way to transfer wealth to minors, providing several unique advantages that make them a popular choice among families.

1. Easy Setup and Management

Setting up a UGMA account is straightforward. All that’s needed is the custodian’s information and the minor’s details. Once it’s established, managing the account is relatively simple. Contributions are not subject to annual or lifetime caps, making it easy to add funds as needed.

2. Tax Advantages

UGMA accounts come with tax benefits that make them appealing for families looking to optimize savings. A portion of the account’s unearned income enjoys reduced tax rates under the “kiddie tax” rule:

The first $1,250 in annual earnings is tax-free.
The next $1,250 is taxed at the child’s rate, which is usually lower than the parent’s or custodian’s.

This can result in significant savings for families compared to keeping all investments in the parent’s name.

3. Financial Ownership and Responsibility

One of the standout features of a UGMA account is how it introduces minors to financial literacy early in life. When they take control of the account upon reaching the age of majority, they gain valuable experience in managing investments and other assets.

4. Flexibility in Use of Funds

Unlike 529 college savings plans, the funds from a UGMA account can be used for any purpose that benefits the child—not just education. This can include expenses like healthcare, travel, or starting a business, giving the recipient flexible options for the future.

Things to Consider Before Opening a UGMA Account

While UGMA accounts offer significant advantages, there are key considerations to keep in mind to ensure they align with your goals.

1. Irrevocable Gifts

Contributions to a UGMA account are irrevocable, meaning you cannot take back the funds or assets once they’re deposited. It’s essential to think through the decision carefully to ensure this aligns with your intentions.

2. Impact on Financial Aid

Assets in a UGMA account are considered the child’s property and can impact their eligibility for financial aid in college. Because these accounts are assessed at a higher rate than parental assets on the Free Application for Federal Student Aid (FAFSA), they may reduce the amount of need-based aid the child receives.

3. Limited Control Post-Majority

When the minor reaches the age of majority, they gain full control of the account. While this empowers them financially, it also means they can use the funds as they see fit—even if their decisions don’t align with the custodian’s original intentions.

4. Tax Implications for High Earnings

For UGMA accounts with high earnings, the unearned income above $2,500 will be taxed at the parent’s highest marginal rate under the “kiddie tax” rule. It’s crucial to monitor the account’s growth to plan for potential tax liabilities.

How to Set Up a UGMA Custodial Account

If you’ve decided that a UGMA custodial account is the right option, here’s a step-by-step guide to setting one up:

Choose a Financial Institution

Most banks, brokerage firms, and credit unions offer UGMA custodial accounts. Compare options to find an institution that aligns with your investment strategy and provides easy account management.

Assign a Custodian

Typically, the custodian is the individual opening the account. Ensure the custodian is financially responsible and prepared to manage the account until the minor reaches adulthood.

Provide Necessary Information

You’ll need to provide details about the custodian and the minor, including social security numbers.

Fund the Account

Decide on the initial contribution, whether it’s cash, stocks, or other permitted assets. Keep in mind that UGMA accounts have no annual contribution limits, but contributions above $17,000 per year (for a single individual in 2023) may incur gift taxes.

Begin Managing Investments

Work with an investment advisor—or use the financial institution’s tools—to create a diversified portfolio that aligns with your financial goals for the minor.

Monitor and Adjust Regularly

Regularly assess the account’s performance and make necessary adjustments to ensure it continues to meet your objectives.

Alternatives to UGMA Custodial Accounts

If you’re not entirely sure whether a UGMA account is the right fit, here are a few alternatives to consider:

529 College Savings Plans: Ideal for families focused on funding education, as they come with significant tax advantages for qualifying expenses.
Roth IRA for Kids: Perfect for minors with earned income, offering long-term benefits like tax-free growth and withdrawals.
Trust Accounts: Provide greater control over how and when funds are used, but often come with higher management fees and legal complexities.

Building a Foundation for the Future

UGMA custodial accounts present an excellent way to secure your child or grandchild’s financial future while teaching them essential money management skills. Their flexibility, tax advantages, and relative simplicity make them a practical option for many families.

However, as with any financial decision, it’s important to weigh the pros and cons carefully. If you have questions or need guidance, a qualified financial planner can help you determine whether a UGMA account aligns with your goals.

Investing in a UGMA account isn’t just about building wealth—it’s about empowering the next generation with financial independence and security. Take the first step toward creating a legacy for your family today.