We all want the best for the children in our lives. It doesn’t matter whether you’re talking about grandkids, nieces or nephews, cousins, neighbors, friends, or even your own children — we all worry. And nobody wants the children they love to face financial hardship in the future.
That’s why custodial accounts offer a great investment opportunity for adults to slowly build wealth for a child over time. But there are two different types of custodial accounts — and each type comes with its own set of rules.
The two custodial account types are UTMA accounts (named after the Uniform Transfers to Minors Act) and UGMA accounts (after the Uniform Gift to Minors Act).
In this guide, we’ll explain everything you need to know about UTMA account rules — including common uses, who pays taxes on an UTMA account, and how an UTMA account is different from an UGMA account.
Before we delve into what an UTMA account can be used for, it’s worth quickly explaining what an UTMA account is.
UTMA accounts get their name from the Uniform Transfers To Minors Act (UTMA).
This was a law recommended by the National Conference of Commissioners on Uniform State Laws (or the “Uniform Law Commission”) in 1986. But because it was only a recommendation, individual states then got to choose whether to adopt the law.
Most of the 50 US states did ultimately adopt the act — with one exception. The UTMA was never ratified in South Carolina.
UTMA accounts are one of the two main types of custodial accounts. A custodial account is an investment vehicle that enables adults to save cash or other assets for minors in a tax-beneficial way.
With a custodial account, the adult who opens it is responsible for managing the funds, investments, or assets as the custodian. But everything in the account legally belongs to the beneficiary minor.
When the minor beneficiary of an UTMA custodial account reaches the age of majority, the custodianship is over, and they get legal control over everything that’s in the account.
It’s important to note that the age of majority is slightly different in each state. In most cases, it’s either 18 or 21. However, in some states, an UTMA takes longer to mature.
Likewise, an adult can elect to maintain custodianship over the assets until the beneficiary reaches up to age 25 — depending on the state in which the account exists.
An UTMA custodial account can be used to hold a range of different asset classes.
Common uses for a custodial account include holding:
Generally speaking, the UTMA offers a tax-efficient way for adults to save for the children in their lives without a major tax burden.
That’s because the Internal Revenue Service (IRS) taxes earnings accumulated in UTMAs at the child’s tax rate up to a certain threshold. Currently, the threshold is $2,200 per year of unearned income.
Bearing in mind that most kids don’t earn as much as their parents, that should mean families stand to save money in taxes by setting up a custodial account.
But an UTMA isn’t the only type of custodial account out there.
The other primary account type you’ll often hear about is the UGMA custodial account. Just like UTMA accounts, UGMA accounts get their name from the law that created them. In this case, that law was the Uniform Gift to Minors Act (UGMA).
This law was originally recommended in 1956, and it was refined a bit more in 1966. Unlike the UTMA, the UGMA has been ratified in all 50 US states. But there are a couple of other key differences, too.
For example, an UGMA is designed to only hold financial asset classes — which means they’re unable to hold ownership of the patent for an invention or an expensive painting. But because most families don’t have those things, this isn’t generally an issue.
UGMAs also generally mature faster than UTMAs. This means that the child in your life will normally be able to access funds you’ve saved for them quicker after reaching the age of majority.
We’ll dive a bit deeper into the rules in just a minute. First, let’s talk about taxes.
Taxes are one area in which the UGMA and UTMA are pretty similar. Because the assets held in custodial accounts are the legal property of child beneficiaries, the IRS taxes the earnings generated by an UTMA or UGMA at the child’s tax rate — but only up to a certain point.
In 2021, the first $1,100 of unearned income is tax-free. “Unearned income” is essentially any profit you make from cumulative interest.
The next $1,100 in profit an account generates is taxed at a rate of 10%.
Any amount of income an account produces that’s more than $2,200 will be taxed at the parent’s higher rate.
Once the child beneficiary reaches the age of majority in your state, they’ll be able to file a tax return of their own. That means the account earnings in their custodial account will then be subject to the tax bracket relevant to their age.
But as always, there’s an exception to the rule when it comes to filing tax returns.
If you’re under 19 or a full-time student under 24 years old, you can keep filing your taxes as part of your parents’ tax return.
It’s also important to consider the IRS gift tax exclusion.
If you gift someone loads and loads of money, the IRS will tax that gift unless its total sum is under a certain threshold. This threshold is called the “gift tax exclusion.” In 2021, the exclusion was set at $15,000 per year.
In short, how UTMAs are taxed can provide families with significant savings — but only up to a certain point. That’s why it’s important to plan and consider tax obligations beforehand.
It’s possible to withdraw money from an UTMA account. However, there’s one essential rule you’ve got to bear in mind — all withdrawals from a custodial account must be for the direct benefit of the beneficiary.
That means if you’re the custodian of an UTMA account and need some cash to pay for the child’s private high school tuition, you’re allowed to withdraw cash from their UTMA.
But many custodial account providers won’t allow you to withdraw money from the account to pay for routine child care expenses.
For example, you won’t be able to take cash out of a child’s UTMA to pay for utility bills or a trip to the grocery store.
These rules will inevitably vary from provider to provider. So if flexible withdrawals are important to you, be sure to do your homework and ask plenty of questions before choosing your custodial account provider.
Unlike some other savings vehicles, there are no IRS penalties incurred when you take money from an UTMA account.
Finally, you can’t afford to forget the golden rule: after the account’s child beneficiary reaches the age of majority, the adult’s custodianship ends.
This means the adult who set up the UTMA account can no longer withdraw money from it ever again, even on the child’s behalf, because everything in the account will pass on to the beneficiary.
When the child beneficiary of a custodial account reaches the age of majority in your state, everything in the account will pass onto them.
The age of majority for an UTMA is different in each state. In most states, the age of majority is 21 — which means that when a child turns 21, the custodianship of assets will end.
But in other states, the age of majority is either 18 or 25.
The custodian can also sometimes choose between a selection of ages. For example, in Virginia, the UTMA custodian can decide whether the beneficiary gets control of the account assets at age 18, 21, or 25.
If you’re setting up an UTMA account in Florida, you’ll have different rules to think about.
In Florida, you can set up an UTMA that will end when the child in your life hits any age between 21 and 25. You get to decide the precise age at which that beneficiary gains access to those assets.
But if you choose anything over 21, you as the custodian need to allow the beneficiary to take ownership within a month of their 21st birthday.
That means you can set up an UTMA account in Florida and say that you don’t want your beneficiary to receive the account funds until they’re 24 years old. But if the beneficiary decides they want access to the account’s assets as soon as they turn 21, you can’t do anything to stop them.
The key takeaway here is simple. When the child in your life comes of age, everything in the UTMA custodial account you’ve created for them becomes their legal property. That’s why it’s so crucial that you fully understand the rules in your state and prepare kids for that transfer of assets.
When an adult decides they’d like to set up a custodial account for a child they love, there are two popular choices: an UGMA or an UTMA account.
We’ve briefly touched upon the key differences, but it’s worth taking a deeper dive so that you understand the broader implications of your choice.
The primary difference between an UGMA and UTMA account is the type of assets each account can hold.
With an UGMA, you’ll be able to store all of the most common financial instruments like stock shares, exchange-traded funds (ETFs), shares in mutual funds, or bonds. An UTMA can hold all of these asset classes, plus some less common classes like precious metals, fine art, or intellectual property.
Next, the UTMA isn’t available in all 50 states — specifically, South Carolina. Because not every state chose to ratify the recommendation act that created the UTMA account, it may not be available where you live. By contrast, UGMA accounts are available in all 50 states.
Finally, the age of majority for an UGMA is normally lower than that of an UTMA.
In most states, the custodianship of an UGMA account will end when the beneficiary reaches either 18 or 21.
With an UTMA, it’s more common for the custodianship to last until age 21 — if not longer. That means if you go for an UTMA, the beneficiary you’re saving for won’t be able to use the assets for a longer period without your consent.
When deciding which account type is best for you and your loved one, keeping all of these considerations in mind is important.
Do your homework to determine the rules in your state and figure out whether UTMA accounts are even allowed. Then, think hard about the assets you’ll want to hold and whether an UTMA is necessary.
For most families, an UGMA account is the natural choice. It comes with all the same tax benefits as the UTMA while offering more freedom to the kids you’re saving for.
If you really want to make the most of that flexibility, setting up an UGMA account with EarlyBird is a fantastic choice for most families.
With EarlyBird, you can gift money directly to a child’s account without having to give it to parents first to deposit on your behalf. You can even gift cash through EarlyBird if the children you’re saving for haven’t got an account yet.
What’s more, you can personalize your gift with a video message.
Custodial accounts are a fantastic investment opportunity for adults trying to slowly build wealth for a child over time. But there are two main types of custodial accounts, and both come with their own set of pros and cons.
What’s important is that you understand your investment needs and do your homework.
Both the UTMA and UGMA enable families and friends to save for the children they love in a tax-beneficial way. But the UTMA isn’t available in every state, takes longer to mature, and can hold different asset classes that UGMAs can’t.
Do you want to learn more about UTMA and UGMA custodial accounts and start saving for the important kids in your life? Download the EarlyBird app today.