If you were looking for a way to invest for your kids outside of a 529, there are other options you might want to pay attention to. We are going to cover what exactly a UGMA/UTMA or Uniform Gift to Minors Act is and whether or not you should open one. Investing or saving for kids is a topic that is brought up quite often. This can be along the lines of your favorite nephew, grandchild, or your own son or daughter that you want to set up financially.
What is a UGMA?
A UGMA is a type of custodial account that you can open on behalf of the beneficiary. In this type of account, you can invest in the stock market. You can invest in bonds, stocks, index funds, mutual funds, etc. and over time the money in this account can grow, which is different than saving in a regular bank account that can lose over time to inflation.
When the beneficiary reaches the age of majority, typically 18 but could be dependent on the state where you live, then that money inside the UGMA gets transferred into full ownership of the beneficiary. They can decide what they want to do with the money. They can keep it inside the account or withdraw it and use it for whatever expenses they see fit.
Who can open a UGMA?
Anyone is eligible to open this type of account. You don’t need to be a parent, you can be a friend, an aunt or uncle, grand parent, it doesn’t matter.
How is a UGMA taxed?
We all know certain investing accounts have different types of taxation rules. In this account, the earnings that you may receive are taxed at the child’s tax rate, also known as the kiddie tax rate. This rate is 0% up to the first $1,250 of unearned income, the next $1,250 at the child’s tax rate, and any additional earnings above $2,500 are taxed at the greater of the child’s or parents’ tax rate.
One other important consideration is the gift tax exclusion. In 2024 any individual can contribute up to $18,000 making these gifts or contributions to the UGMA tax-exempt.
What are the UGMA contribution limits?
The $18,000 gift tax exclusion limit per individual or $36,000 per couple is in effect for 2024. If you go above those limits, then that’s when you fall into those taxation requirements and form 709 must be filed. Keep in mind, the contribution limit is per individual per beneficiary. If you are married with 3 children, you can contribute a maximum of $108,000 before reaching the taxation requirements.
Pros and Cons
Pros
· You can withdraw the money from a UGMA and spend it on anything that benefits that child.
· No early withdrawal penalties.
· You can invest in various things that can help the money grow.
· Other family and friends can also contribute to the UGMA.
Cons
· Can count as a source of income and an asset when determining eligibility for financial aid.
· Not a tax-sheltered account
· You lose control when the minor reaches the age of majority.
· Assets placed in the account are irrevocable. Meaning once you contribute, they belong to the minor.
Why might you want a UGMA?
You might want a UGMA if you don’t want to go through the hassle of setting up a specific trust fund. You might also not like the restrictions a 529 plan holds. Keep in mind, the 529 is set up to fund educational expenses which is broad ranging from trade school, K-12, and now even being able to roll those funds into the beneficiary’s Roth IRA up to a lifetime limit of $30,000.
If you want to gift money to a minor and see that grow beyond what a typically savings account has to offer, then a UGMA might be up your alley. However, if you aren’t a big fan of the transfer of ownership at age of majority, you can also consider saving in your own brokerage account to remain full owner of those funds.
Before opening a UGMA make sure you understand the pros and cons as well as the taxation rules. There aren’t many scenarios where I recommend a UGMA. Most people prefer to have the flexibility of operating their own brokerage account. If you are struggling to decide which option is best for you, use the link below to schedule some time with me.
Five Pine Wealth Management is an Investment Adviser registered with the Securities & Exchange Commission (SEC), principally located in the state of Idaho. All views, expressions, and opinions included in this communication are subject to change. The information provided should not be relied upon as the sole factor in an investment making decision. Past performance is no guarantee of future results.