UTMA Unhappiness

Irrevocable gifts to minors don’t always work out.

Think twice before creating an UTMA account. Custodial investment accounts permitted under the Uniform Transfers to Minors Act (UTMA) allow families to gift assets to a child without having to set up a trust. In addition to that convenience, an UTMA can offer a distinct tax advantage to parents. While such perks are nice in the present, the bigger question is what will happen to those assets down the road.1

What potential benefits do UTMA accounts offer to families? Assets in an UTMA account (or UGMA account, the earlier version still used in a few states) are owned by the child, not the parents. As a result, UTMA investment income is generally taxed at the child’s tax rate instead of the parents’ tax rate. That can mean big savings – unless the “kiddie tax” strikes.1,2

In 2013, the first $1,000 earned by an UTMA account is tax-free, providing that child has no other income and is younger than 19 (or younger than 24 and a full-time student whose unearned income does not provide 50% of his/her support). The next $1,000 of investment income from the UTMA is taxed at the child’s tax rate. The kiddie tax kicks in at the $2,000 threshold: account earnings above $2,000 are taxed at the parents’ top marginal tax rate and become part of the parents’ taxable income. (One asterisk: all income will be reported on the child’s tax return if he or she is age 19 and not a student, or age 24 regardless of student status.) Practically speaking, wealthy families can potentially see tax savings via an UTMA account by shifting ownership of some fixed-income securities in a portfolio to a child. As capital gains and dividends aren’t taxed as ordinary income, there is a little less merit in passing such investment income off to a minor.1,3

College keeps growing more expensive, and certain families are just too wealthy to be eligible for financial aid. Some parents create UTMA accounts in response to this dilemma. 3

What are the potential drawbacks of UTMA accounts? First of all, the gifts and transfers you make to the minor via the account are irrevocable. The adult custodian only has control over those assets until the minor turns 18 (though UTMA custodianships can last up to age 21 or age 25 in some states).1

Once the UTMA custodianship ends, the young adult now in control of the assets can use those assets for any purpose. Anything. What was once seen as a college savings fund may potentially “go to waste” on trivial pursuits.4

Many affluent families assume that their children can’t qualify for college loans, and that their kids are out of the running for need-based scholarships and grants. This often proves inaccurate. So if you aren’t yet a multimillionaire, there may not be much reason to have an UTMA account as a college savings fund – it may reduce your student’s eligibility for aid. College financial aid formulas usually demand that students contribute more of their total assets to college costs each academic year (in the neighborhood of 20-25%, sometimes as much as 35%). Parents are typically asked to contribute a much lower percentage of their total assets per year. While there may be a silver lining in proceeding through college with less financial aid (i.e., lower student loan debt for the future), it still amounts to “good debt”.1,2,4

UTMA accounts are hardly the only option. If you want to make a gift to a child or help a child save for college, in the end you may determine that a trust, a Coverdell ESA or a Roth IRA represents a more appropriate choice. If you have questions about saving for college or retirement please feel free to call.



1 – individual.troweprice.com/public/Retail/Products-&-Services/College-Savings-Plans/Gifts-&-Transfers-to-Minors [5/16/13]
2 – forbes.com/sites/baldwin/2013/02/28/using-utma-and-ugma-accounts-for-college/ [2/28/13]
3 – cbsnews.com/8301-505123_162-57581648/investment-accounts-for-kids/ [4/26/13]
4 – smithbarney.com/products_services/planning_services/education_planning/custodial_accounts.html [5/16/13]
5 – individual.troweprice.com/public/Retail/Planning-&-Research/College-Planning/Which-Option-is-Right-for-Me [5/16/13]

All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment. This material was prepared by MarketingLibrary.Net Inc., for Mark Lund and independent Investment Advisor, Investor Coach and author of The Effective Investor. Located in Salt Lake City and Provo Utah.