What Is the Uniform Gifts to Minors Act (UGMA)?

The Uniform Gifts to Minors Act (UGMA) facilitates the transfer of assets to minors without the complexity of setting up a formal trust. Established in 1956 and updated in 1966, it primarily serves as a vehicle for parents to transfer assets to their children, free from gift tax within certain limits. Assets are commonly held in UGMA accounts on behalf of minors, bypassing the need for a trust fund established by an attorney. UGMA funds also benefit from special tax considerations.

**Key Takeaways**

• The UGMA simplifies asset transfers to minors, eliminating the need for a formal trust.
• Assets in a UGMA account are managed by an adult custodian until the minor reaches the age of majority, at which point the minor gains control.
• Earnings from UGMA accounts are taxed at the minor’s lower kiddie tax rate, up to a certain threshold, offering tax advantages.
• UGMA accounts are versatile and straightforward, allowing funds to be used for various purposes.
• UGMA accounts are irrevocable and do not provide tax benefits to the donor.

Investopedia / Mira Norian

How a UGMA Account Works

A UGMA account operates as a custodial account designed to safeguard assets for the minor beneficiary. The donor can appoint themselves, another individual, or a financial institution as the custodian. The custodian holds the power to invest in various securities on behalf of the minor.

UGMA accounts can be opened through banks or brokerage institutions, allowing contributions from friends and family without limits on contributions or income. Contributions are made post-tax, making them irrevocable transfers to the minor’s account. Hence, the transfer cannot be undone.

Typically used for funding a child’s education, UGMA assets can be withdrawn for any expenses benefiting the beneficiary. While there are no withdrawal penalties, these assets count towards the minor’s assets when applying for federal financial aid, potentially affecting eligibility.

Upon reaching the age of majority, minors gain full access to their UGMA account, allowing them to utilize the funds as needed. Custodians are entrusted with managing the account in the best interest of the beneficiary.

Special Considerations

Minors or beneficiaries are deemed the owners of UGMA account assets and their generated income for tax purposes. However, income from these accounts might be taxed to either the child or the parent, contingent on the income amount and the beneficiary’s age.

Contributions to a UGMA account can affect a donor’s lifetime gifting limits for tax purposes. In case the custodian-donor passes away before transferring the custodial property, the entire property is included in the donor’s taxable estate.

For the year 2022, up to $16,000 per individual can be contributed tax-free, with this amount increasing to $17,000 for 2023.

Uniform Gifts to Minors Act (UGMA) vs. Uniform Transfers to Minors Act (UTMA)

The terms UGMA and Uniform Transfers to Minors Act (UTMA) are often used interchangeably, with the UTMA being an extension of the UGMA, created in 1986. Both require the naming of a custodian to manage and invest assets until the beneficiary reaches maturity, asserting that gifted assets belong to the minor.

Distinctions exist between UGMA and UTMA. While UTMA accounts can hold various assets, including real estate and intellectual property, UGMA accounts are constrained to financial assets like stocks and bonds.

UTMA allows children to invest without incurring tax burdens. In 2022, the IRS’s gift tax exclusion was up to $16,000 per person ($17,000 for 2023), including gifts to minors.

UGMA vs. 529 Plans

Unlike UGMA accounts, 529 plans involve no withdrawal penalties, providing the flexibility to cover various expenses, including educational costs. 529 plans offer a tax-advantaged savings structure tailored exclusively for qualified educational expenses.

Parents can use 529 plans to save for educational expenses starting from kindergarten, covering tuition, equipment, and living costs, in addition to apprentice program expenses. Contributions to 529 plans have state-specific limits, allowing tax-deferred growth and tax-free withdrawals for qualified education expenses.

529 plans come in two forms:

• Prepaid Tuition Plans: Lock in future tuition costs at current rates for specific colleges and universities, offering savings on future expenditures.
• Savings Plans: Function akin to individual retirement accounts (IRAs).

UGMA accounts are restricted to publicly traded financial assets, precluding investment in speculative instruments like derivatives or margin purchases.

Advantages and Disadvantages of UGMA

Utilizing UGMA for a minor’s future entails various benefits and drawbacks. Below are common advantages and disadvantages associated with UGMA accounts.

**Advantages**

– UGMA accounts are straightforward to set up and comprehend, permit contributions from any individual, and can be initiated through financial entities or brokerage firms.

– There are no contribution or withdrawal restrictions in UGMA accounts, though IRS gift tax limits apply. Funds can be withdrawn at any time for any purpose.

– UGMA accounts offer flexibility in fund usage, not limited to educational expenses like other plans.

– By bypassing the trust process, UGMA guarantees automatic ownership transfer to the minor, clarifying ownership issues.

**Disadvantages**

– UGMA accounts are irrevocable, once assets are transferred, they belong to the minor, prohibiting amendments or reversals.

– UGMA assets might impact the beneficiary’s future financial aid eligibility if considered the child’s property, potentially reducing or disqualifying aid.

– UGMA accounts lack tax advantages, differing from programs like 529 plans that provide tax credits or deductions.

**Pros**

• Easy to set up and understand

• No contribution or withdrawal limitations

• Offers greater flexibility

• Bypasses the trust establishment process

**Cons**

• Irrevocable

• Can influence eligibility for financial aid

• Lacks tax benefits

Contribution Limits and Taxes

While there are no defined contribution limits for UGMA accounts, deposits may be regarded as gifts, subject to IRS regulations.

Parents can gift up to $16,000 annually per child without tax implications for 2022, increasing to $17,000 in 2023.

In certain scenarios, parents might report their children’s UGMA account income on their tax returns, leveraging the kiddie tax enactment. This allows reporting a child’s income on the parent’s return if the child’s unearned income, including UGMA earnings, is below specific thresholds based on age.

Under this rule, a portion of the child’s unearned income is tax-free, subject to specified limits. Any excess income may be taxed at the parent’s rate if criteria are met.

How Are Gifts to Minors Taxed?

Financial gifts up to $16,000 in 2022 are exempt from taxes, increasing to $17,000 in 2023. Amounts exceeding this threshold are subject to taxation.

What Is a Downside to the Uniform Gifts to Minors Act?

As UGMA account assets belong to the minor, it can affect their eligibility for financial aid, potentially disqualifying them based on the account’s value.

Where Can I Open a Uniform Gifts to Minors Account?

A Uniform Gifts to Minors account can be established at a brokerage firm or bank, allowing contributions from anyone. Depositors must remember that deposited assets are irrevocable and become the beneficiary’s property.

The Bottom Line

Securely investing in a child’s financial future is vital, and the Uniform Gifts to Minors Act serves as a viable option. UGMA accounts are user-friendly, accommodating cash and asset contributions to a single minor beneficiary. Offering comprehensive flexibility, they can be used for diverse purposes. However, do note that UGMA accounts lack tax advantages and the deposited funds become irrevocable instantly. For advice on selecting the optimal account type for your beneficiary, consulting a financial expert is recommended.