UTMA 101

How the Uniform Transfer to Minors Act Can Help Pay For College

UTMA 101
May 16, 2014

The UTMA (Uniform Transfer to Minors Act) allows you to establish custodial accounts for the benefit of minors. The act allows minors to receive gifts of money, real estate or other valuables once they reach a certain age, without a guardian or trustee. UGMA accounts were established under the preceding Uniform Gifts to Minors Act, and are similar except for more restrictions on assets.

Under the UTMA, an account is established by a donor, often a parent or grandparent, and property is transferred into this account for the future use of a designated minor. The investments could be cash, savings accounts, CDs, savings bonds, and stocks. Real estate, jewelry, artwork, and other valuable personal property may also be included. However, once assets are transferred, they cannot be taken back – similarly to an irrevocable trust. You also cannot switch beneficiaries.

The donor or designated custodian manages the account until the minor reaches the age of transfer (usually 18 or 21 years old). At that point, all assets are in the account are transferred to the minor, who can then do with them whatever he or she wishes.

With respect to college costs, a UTMA custodial account is not the best way to go, but it can play a useful role.

The advantage of a UTMA for college is that there is no limit – you can store enough for an entire college education if you want. The disadvantage is that the assets are the child's to spend in any way they please. There is no guarantee they would use it for college at all – and that is a lot of responsibility to ask of someone of that age. If you want to set aside significant amounts of money, a trust may be a better way to go to keep some amount of flexibility and control.

Another drawback of a custodial account is that the majority of the account will be taxed at the custodian's tax rate (generally you as the parent).

Custodial accounts are also counted as student assets for financial aid testing, seriously hampering the likelihood of receiving aid.

The best way to use a custodial account is probably to convert it into a custodial 529 account. 529 plans are state-operated plans that allow you to establish an account for funds to build tax-free as long as they are used for educational purposes. Anyone can contribute to a 529 plan, not just parents – even the child can contribute.

In addition, 529 account assets are considered custodial assets and not the child's assets, counting at a 5.6% rate toward the expected financial aid contribution (compared to the 20% rate for the child's assets).

Contributions to 529 plans can only be made in cash – so all non-cash assets in the custodial account must be liquidated prior to transfer. Look into all the capital gains taxes and costs associated with liquidation – If they are too large, you are better off setting up a separate 529 and leaving the custodial account alone.

UTMA custodial accounts were at one time the best choice for college savings, but with legislative and tax changes and the advent of 529 plans, they really are not an efficient college saving option anymore. They will not harm those with greater means, but they do not offer much advantage.

If you currently have a UTMA account for a child, your best bet is to transfer it to a 529 account or drain it down against other expenses of your child so that the account plays a smaller part in the financial aid picture.

Photo ©iStockphoto.com/Devonyu

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