UGMA 101: A Parent's Guide to Custodial Accounts

My second-grader is learning to add more complicated sums by borrowing numbers (adding 400 + 83 is easier than 398 + 85). The lesson is that there’s more than one way to make the math work.

Parents know there are multiple ways to make the math of saving money work out as smoothly as possible, too. When you’re saving for your child’s future, you have a number of account options to choose from. An UGMA account can help you start building investments on your child’s behalf, so it can be a useful part of the equation as you prepare to send your child to college or help them get established on their own.

What Is an UGMA Account?

UGMA stands for Uniform Gifts to Minors Act, and it’s a type of custodial account (meaning it’s managed by an adult on behalf of a minor). Minors aren’t legally allowed to enter into contracts. Generally, this means they can’t own stocks, bonds and mutual accounts. In most states, the minimum age to invest in and trade stocks is 21, and in 10 states, the minimum age is 18. A custodial account or a trust can hold investments until children come of age. Presumably, you'll want to teach them about investing so they are prepared to take over when the time comes.

With a typical trust fund, parents would have to work with an attorney or go through court to prepare documents and appoint a trustee. An UGMA account follows a state statute’s terms, so it can be simpler to set up.

UGMA vs. UTMA

You might see UGMA accounts discussed alongside Uniform Transfers to Minors Act (UTMA) accounts. They’re similar but not interchangeable. UGMA and UTMA accounts are both custodial accounts and follow similar rules. A key distinction is that an UGMA account can only hold securities like stocks, bonds, mutual funds and cash. UTMA accounts can hold these as well, but they can also hold other types of property (e.g., real estate, art, heirlooms). UGMAs are available in every state, but South Carolina does not permit UTMAs.

When it comes to choosing an UGMA or UTMA for your child, compare requirements in your state and consider what you’d like to contribute to the account. If you’re interested in setting up financial investments on your child’s behalf, an UGMA may offer everything you need. If you’d like to put other property (e.g., a car) in your child’s name when they’re a minor, an UTMA might work better.

Who Owns the Assets in an UGMA Account?

The contents of an UGMA account belong to the child, even if they’re a minor and can’t manage stocks on their own yet. Transfers that go into an UGMA or UTMA are irrevocable. An UGMA account has a custodian with a fiduciary responsibility, meaning they’re legally bound to act in the best interests of the child. In many cases, you as the parent will act as custodian to make decisions for the account — which can also be a great opportunity to show your child what you’re doing and teach some basic investing knowledge.

When your child comes of age (at 18 or 21 in most states), the custodianship ends and the child has full access to the account. At that point, it’s their property and they can use money in the account however they want, without parental permission.

UGMA Account Limits and Taxes

Anyone can contribute to an UGMA account, including grandparents or other relatives. Contributions come from after-tax dollars, and you can contribute up to $16,000 or $32,000 for a married couple.

UGMA and UTMA accounts don’t offer as many tax advantages as some other accounts (e.g., 529 college savings account), but they also don't have the same level of limitations and maximums as other child investing accounts. While 529 earnings accumulate tax free, you may need to pay taxes on some earnings in an UGMA or UTMA. 

In 2022, the first $1,150 of unearned income for a minor is tax free. The next $1,150 is taxed at the child’s tax rate, which is typically much lower than the parent’s. Any unearned income over $2,300 is taxed at the parent’s tax rate. This tax rule is meant to prevent parents from creating a tax shelter for themselves by gifting stocks and other investments to their children.

How UGMA Accounts Affect Financial Aid

You can use an UGMA account to build cash and investment funds for your child’s future. For example, you might be hoping your child will pursue a college education and want to save toward that. When it comes to planning for college, you want to consider all the financial options available to you, including your own preparations and the financial aid package from the school.

Most colleges and universities use the FAFSA to calculate financial aid, and the FAFSA assesses parent and student assets differently. In both cases, parents and students have a certain amount of assets that don’t factor toward their expected contribution to college costs. Above that limit, parent assets get assessed at up to 5.64 percent, and student assets get assessed at up to 20 percent. 

That means your child’s financial aid goes down by the percent of that asset. So if a student account has $10,000 and gets assessed at 20 percent, that’s $2,000 that comes out of your eligibility for need-based financial aid. A parental asset with $10,000 would only reduce financial aid eligibility by $564. Presumably, the FAFSA powers that be feel like funds in the child’s name probably aren’t as crucial for supporting a family and could feasibly be dedicated more toward their education.

Pros and Cons of Opening an UGMA

There are numerous account types you could use to save for college. The main benefit of an UGMA compared to another account like a 529 is that once your child comes of age, they can use UGMA funds for any purpose. When you take funds from a 529 account, you need to use them for qualified education expenses or you’ll get hit with taxes and penalties. Qualified expenses include things like tuition, but there can be some college expenses that don’t count as “qualified.” For example, student transportation or health fees aren’t qualified.

An UGMA can also be a more beneficial account for your child if they choose a path other than higher education. UGMA funds could help your child afford a first place to live or pay for a major life event like a wedding. 

The biggest con we see is that UGMA funds count as a student asset, so they will have a bigger impact on your eligible financial aid, dollar for dollar, than funds in a 529 (which count as a parent asset, since the parent is the account owner). 

Setting up an UGMA can be a way to set aside funds for important college expenses a 529 won’t cover. Here's how the two stack up in the UGMA vs. 529 debate.

Much of this will come down to what you're trying to accomplish with these funds. For example, we spoke to one mom who created UGMAs for her kids because she wanted them to have maximum flexibility.

(Here's a rundown of leaving money for your kids in a UGMA vs. last will and testament, too.)

How to Open an UGMA

UGMA accounts are available in all 50 states. You can open an account through many banks, brokerage firms or some other financial institutions. In fact, you can open one through Fabric by Gerber Life. Make the process as smooth as possible with these tips:

• Compare terms: Different companies may offer UGMAs with different investment options.

• Read fee details: UGMAs may charge different fees depending on which company you go with and how much you manage the account yourself versus use a financial advisor’s services.

• Check your state age of majority: How old will your child be when they can take control over the account?

Preparing a steady financial foundation for your child is a long-term process, and it’s smart to start early. Saving money and teaching your child financial skills (like understanding how investing works) can position your child for success. An UGMA can be a helpful tool to introduce your child to investing and build funds they can use as they enter adulthood.

Fabric exists to help young families master their money. Our articles abide by strict editorial standards.

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