Uniform Gifts to Minors Act
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The Uniform Gifts to Minors Act, commonly known as UGMA, is an act in some states of the United States that allows assets such as securities, where the donor has given up all possession and control, to be held in the custodian's name for the benefit of the minor without an attorney needing to set up a special trust fund. This allows minors in the United States to have property set aside for their benefit, and may achieve some income tax benefit for the child's parents. Once the child reaches the age of majority (18 or 21 depending on the state), the assets become the property of the child and the child can use them for whatever purpose it chooses.
In the majority of states that have adopted the Uniform Transfers To Minors Act (UTMA), the assets are treated similarly: the assets are held in the custodian's name until the child reaches age of majority. States that adopted UTMA also repealed UGMA; UTMA specifically provides that contracts in UTMA states which reference UGMA are governed by UTMA. Thus, UGMA is often still referred to in contracts designed for use in multiple states, even though it may actually mean UTMA in a particular state.
The Internal Revenue Code of the United States allows persons to give up to the annual gift tax exclusion to another person without any gift tax consequences. If the recipient is a minor, the UGMA or UTMA allows the assets to be held in the custodian's name for the benefit of the minor without an attorney setting up a special trust fund. Under the UGMA or UTMA, the ownership of the funds works like it does with any other trust except that the donor must appoint a custodian (the trustee) to look after the account.
A UGMA or UTMA account allows the assets to be taxed at the minor's income tax bracket. With the increase in the age from 14 to 18 where the kiddie tax is imposed, the tax advantage of a UGMA or UTMA is decreased. As of 2007 only approximately $1,700 of the child's unearned income can avoid being taxed at the child's parent's tax rate.
Problems with UGMA/UTMAs
Before you set up a custodial account for a minor, (known as an UGMA or an UTMA) consider whether a custodial account is really the best choice. These are generic, one-size-fits-all savings accounts that the child has 100% control over once reaching age 21 (as early as 18 in some states). UGMA or UTMA accounts are NOT trusts and do NOT offer the control to the custodian Know What You Are Buying Custodial accounts are rarely explained clearly by the sponsoring bank or mutual fund establishing the account. These accounts are no more than inflexible savings accounts. Consider that even a few hundred dollars into an account at birth can be worth thousands of dollars twenty years later. How much would that have tempted you at age 18? Would you have spent the money wisely? Over 95% of UGMA’s are cashed in by the age of 25 – that’s why stock brokers refer to these as “Spring Break Accounts.” However, a trust, being its own legal entity, gives you the ability to set parameters on when assets are available and for what they can be used for. You Can't Limit or Restrict Use Once you've transferred assets into a custodial account, you're not permitted to restrict the use of assets. Those assets belong to the child. So even if you meant for the funds to only be used for college … the money could be used as a great down payment on a Harley-Davidson. Unlike custodial accounts, trusts allow for the use of the assets to be restricted. For example, the trust assets could be limited to education related expenses only. Did You Say Age 21? When your child turns 21 (or an earlier age, in some states), the assets will be turned over to the child. Some people are mature and thoughtful at age 21 or earlier; many are not. Do you really want all that money in your child's hands at that age? How would you feel if she uses it to buy equipment for her boyfriend's rock band? However, with a trust you can set the age when access is provided and even set limits on how much can be accessed at different ages. For more information use this link for a list of applicable ages by state. Reduces Financial Aid Some people think of a custodial account as a good way to save for college, only to learn later that the account causes a reduction in financial aid. Under current law, assets owned by the child (including any assets in a custodial account for the benefit of that child) count much more heavily than parental assets in determining how much financial aid the child qualifies for. Trusts however, can be structured to avoid this trap. Death of the Child If your child dies before receiving the account, the assets will pass according to the laws of your state. Often the result is not what you would have wished, especially if the child has siblings. When you establish a trust for your child, you can plan for this possibility. UGMA and UTMA's do not provide this flexibility. Alternatives Before establishing a custodial account, you should carefully consider your objectives and other ways you may achieve them. One possibility is to setup an irrevocable trust and transfer the assets from an existing UGMA or UTMA to fund the trust.
