Every parent wants to provide for their children. A safe home, good education, and food on the table are all things that children need, but many parents want to go further and set their children up for financial success.
The Uniform Gifts to Minors Act (UGMA) adopted in 1956 created a special type of account, the UGMA account, that lets parents, grandparents, aunts, uncles, and family friends give financial gifts to children.
With a UGMA account, these people can give gifts to children without giving them full control over the money. Instead, a custodian can manage the money until the child is old enough to accept responsibility.
UGMA accounts are highly flexible and can be a great way to give a gift to a loved one. It’s important to understand how they work and their pros and cons before setting one up.
How Do UGMA Accounts Work?
An UGMA account is a type of custodial account that an adult opens for a child in their life. The adult, known as the custodian, maintains control of the account through the child’s young years. They’re responsible for properly investing the money within the account.
Then, once the child reaches the age of 18 or 21 (depending on the state), they gain full access to the account and the assets within it.
One of the key features of an UGMA account is that when someone contributes money or other assets, it is an irrevocable gift. Contributors can’t take their gifts back. Even though the child doesn’t immediately gain control of the account, they technically own everything within it.
In almost all cases, the assets must stay in the account until the child reaches adulthood and takes control of the account.
There are some situations where the money can be used for the benefit of the child. But parents can’t use the money for any of the basic costs that come with raising kids.
If you feel you have extenuating circumstances that might allow you to withdraw money from an UGMA account, consult a legal or financial professional.
What assets can an UGMA hold?
UGMA accounts are a way for parents and other loved ones to transfer financial assets to a child in their lives. UGMA accounts can hold many different financial assets, including individual stocks, bonds, index funds, mutual funds, cash, and insurance policies. UGMA accounts can’t hold physical assets such as real estate.
UGMA account custodians can choose how to invest the assets within an UGMA account.
The options will vary depending on the brokerage firm you open the account with. Regardless of the broker, custodians can’t invest assets within an UGMA account in high-risk investments like options and other derivatives.
Custodians have a fiduciary duty to the beneficiary. In other words, they have a legal and ethical duty to act in the best interest of the child when making investment decisions.
UGMA accounts with EarlyBird
EarlyBird offers parents and other loved ones a simple and innovative way to open and contribute to an UGMA account. Once the custodian opens the EarlyBird account, they can invite other loved ones to contribute. In just a few steps, loved ones can transfer money into the child’s account.
EarlyBird custodians can choose between five different ETF portfolios ranging from conservative to aggressive. They can also allocate up to 5% of the assets to go toward value-based funds that support causes such as environmental protection and diversity.
The investment options that EarlyBird offers make it easy for adults to make the best decisions based on their risk tolerance and the time horizon. Additionally, the value-based funds allow parents to teach their children about the importance of investing in issues they care deeply about.
Anytime a loved one contributes to the child’s account, it is automatically invested based on the choices selected by the custodian.
Once the child reaches adulthood, they gain full control of their EarlyBird account and can use the money for any goals they have, big or small.
UGMA vs. UTMA account
Like a UGMA account, a UTMA account is a type of custodial account that parents and other loved ones can open for the children in their lives.
UTMA accounts were created in 1986 under the Uniform Transfers to Minors Act.
In most ways, UTMA accounts are identical to UGMA accounts. Parents and loved ones can contribute to the account, and a custodian controls it. Then, when the child reaches adulthood, they gain full control.
But there are two important differences between the two accounts. First, UTMA accounts can hold more types of assets than UGMA accounts.
The first difference between the accounts is where they’re available. UGMA accounts are available in all 50 states. But South Carolina and Vermont haven’t adopted the Uniform Transfers to Minors Act, meaning families in those states can’t use UTMA accounts.
The other difference between the accounts is the types of assets they can hold.
UGMA accounts can hold financial assets such as stocks, bonds, index funds, mutual funds, cash, and insurance policies. UTMA accounts can hold all of the same financial assets. But they can also hold physical assets such as real estate and collectibles.
If you’re considering opening a custodial account for a loved one, you might wonder whether an UGMA or UTMA is the right choice.
In almost all cases, an UGMA is a great option. An UTMA only becomes necessary if you plan to transfer physical assets to a child.
Who can contribute to an UGMA account?
UGMA accounts are a way for the loved one’s in a child’s life to make a financial contribution to their future.
Technically anyone can open an UGMA account for a child. Grandparents, godparents, and other loved ones might choose to open one to easily transfer money to the child throughout their young life.
Most often, though, it is the parents who open UGMA accounts for their children.
Fortunately, the EarlyBird platform makes it easy for parents to share these accounts with other loved ones so that anyone can contribute to one account — so the child’s entire network of family and loved ones can collectively contribute to their financial wellbeing.
In just a few steps, anyone can contribute to the EarlyBird UGMA account for a child in their life.
Plus, EarlyBird takes it one step further by allowing contributors to leave a video message for the child.
When the child reaches adulthood, they’ll not only gain access to the money in the account, but they’ll also have a wealth of cherished memories to watch and keep forever. Whenever they log into the account, they’ll see their memories feed filled with video keepsakes from monetary gifts provided over the years.
Pros of UGMA Accounts
UGMA accounts are an excellent way for parents and other loved ones to save for a child’s future. There are many benefits to a UGMA account, but we’ll highlight a few of the biggest.
UGMA accounts come with a few tax advantages you should be aware of.
First, thanks to the high IRS gift limits, it’s unlikely that parents and other loved ones have to worry about filing a gift tax return.
The federal government allows individuals to transfer up to $15,000 of gifts to another individual each year before they must file a gift tax return.
And even if you do have to file a gift tax return, it’s unlikely you’ll ever have to worry about paying gift taxes.
Once you reach the $15,000 annual exclusion, the amount you gift reduces your lifetime exclusion. As of 2021, the IRS allows individuals to gift up to $11.7M in their lifetime before paying gift taxes.
UGMA accounts also come with tax advantages for the receiver. Under federal law, the first $2,200 of a child’s unearned income (including income from UGMA accounts) comes with tax perks. The first $1,100 is tax-free, thanks to the standard deduction for dependents. The next $1,100 is taxed at the child’s tax rate, which is likely to be lower than the parent’s.
Perhaps the most significant benefit of UGMA accounts is the flexibility that comes with them. Unlike other types of investment accounts for children, there’s no limit to what the recipient can spend the money on.
With a 529 college savings plan, children only get the full benefit of the money if they spend it on educational expenses. If they spend it on anything else, they’ll pay a significant tax penalty.
A custodial IRA, another type of investment account for minors, is intended for retirement savings. So the money into that type of account during your child’s young years can’t be spent until they retire.
But an UGMA account comes with none of those restrictions.
Many parents might turn to an UGMA account to save for the child’s college education, which is great. That money will certainly come in handy when the child heads off to school.
But UGMA accounts aren’t just for college savings. If the child decides not to attend college or receives a scholarship to pay for school, they can use the funds in their UGMA account on any goal.
Whether they want to travel the world or settle down with a house and kids, the money is theirs to use freely.
No contribution limits or rules
Another benefit of UGMA accounts is that there are no limits on how much a parent or loved one can contribute to a child’s account.
Other investment accounts for children come with rules for how much you can contribute.
For a custodial IRA, only $6,000 can be contributed to the account. Additionally, to contribute to an IRA account, the recipient must have earned income.
And while a parent can contribute to an IRA on their child’s behalf, they can only contribute up to the amount of earned income the child had, or $6,000, whichever is lower.
529 college savings plans also come with limits as to how much the child’s parents and loved ones can contribute over the life of the account. Though the limits for 529 plans vary by state, they range from $235,000 to $529,000.
You might be thinking that the limits on 529 plans are so high that it’s not really a drawback. And while you’re right that the limits are high, it can still be a problem for many.
$235,000 is a lot of money for a child who plans to get an undergraduate degree. But when it comes to higher education such as law school and medical school, that amount of money is probably not sufficient.
So even those families who can afford to fund their child’s education through the doctorate level, they likely can’t use a 529 plan to do so.
Cons of UGMA Accounts
UGMA accounts are an excellent way to financially contribute to your child’s future. And while there are many benefits to these accounts, there are also a couple of drawbacks worth discussing.
Just as there are tax benefits to UGMA accounts, there are also tax drawbacks to be aware of.
Money that a child earns in an UGMA account is considered unearned income. There are some benefits to a child having unearned income — the first $1,100 is tax-free, and the next $1,100 is taxed at the child’s tax rate.
But because of what is known as the “kiddie tax” law, the benefits disappear after that first $2,200. The kiddie tax was implemented in the Tax Reform Act of 1986. Its purpose was to prevent parents and other relatives from avoiding taxes on their investments by transferring them into an account in their child’s name.
Under the kiddie tax law, a child’s unearned income that exceeds $2,200 is taxed at the parent’s tax rate.
Unearned income includes interest income, dividends, capital gains, royalties, and more. It doesn’t include any income the child earned at a part-time job — that earned income is only taxed at the child’s tax rate.
Giver loses control of funds
Any money someone contributes to an UGMA account is an irrevocable gift. In other words, once it goes into the account, the giver can’t take it back. And while the account’s custodian manages the account and controls the investment decisions, they don’t actually have ownership of the assets.
Once assets go into an UGMA account, they are the property of the child whose name is listed on the account. While they are still minors, they can’t access the funds. But once that child turns either 18 or 21 (depending on the state), they gain full control of the account.
In some ways, this is a great thing. They’re adults and are finally able to use the money in their UGMA account to reach their goals. But there could also be some downsides to this arrangement, and some parents may worry whether it’s really best for their child.
As a parent, grandparent, or any other loved one contributing to a child’s UGMA account, you might have some idea of what they’ll use the money for. Maybe you hope they’ll use it to pay for college, travel the world, or start a business.
But once the child takes ownership of the account, they can do anything with the money. And unfortunately, they could make bad choices with the money or quickly spend it with little thought.
For children with a significant amount of money in their UGMA account, the damage could be severe. Unfortunately, this could lead to a hard learning experience for some young adults.
This risk is one of the reasons EarlyBird values and supports teaching financial literacy to kids.
As you help grow their investment, you can teach them smart spending and investment habits. So, when they do come of age they will be responsible enough to handle their finances wisely.
Impact on college financial aid
One of the most significant downsides to UGMA accounts is the way they’re treated when it comes to financial aid eligibility.
When someone applies for financial aid, both their assets and their parent’s assets are taken into account. Colleges only expect parents to use up to 5.64% of their assets toward a child’s college education. As a result, any money in a parent’s investment account is likely to have only a small impact on a child’s financial aid eligibility.
A child’s assets, however, count for significantly more. Colleges expect that students will use up to 20% of their personal assets to pay for college. And because the assets in an UGMA account belong to the child, they’re weighted more heavily.
This is certainly something to keep in mind when opening an UGMA account for a child in your life. A few possible alternatives could include keeping the money in a parent’s investment account or using a 529 plan, which counts as a parent’s asset for financial aid.
As you weigh the pros and cons, however, it’s important to keep things in perspective.
While assets in an UGMA do reduce the amount of financial aid a child is eligible for, they can use the money in that account to pay for college. And the flexibility that comes with UGMA accounts often outweighs the financial aid perks of alternative accounts. Especially if you’re not 100% sure the child will want to attend college.
UGMA accounts are highly flexible accounts that let you give financial gifts to a loved one. You can make an immediate gift without giving a child who isn’t ready to manage money and investments full access to the funds.
Despite their many advantages, UGMAs do have some drawbacks to consider before you form one, so take a moment to consider how they could impact the child’s future, and if they’ll be ready to take full control of the money by the time they become an adult.
EarlyBird makes it easy for a child’s loved ones to contribute to an UGMA account and have a meaningful impact on the child’s future.
Download EarlyBird on the app store today to start investing in the kids you love.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.