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Saving for college fees may be daunting, but being able to save even tiny amounts throughout the years may give your child a good head start when their college time arrives. Although many people are aware of tax-advantaged investment accounts such as 529 plans, you may be unaware of the existence of UGMA/UTMA accounts, an additional avenue to save for school and other expenditures.
In this post, we'll look at UGMA and UTMA custodian accounts, what they are, and how to figure out the best approach to invest for your children's future while receiving tax benefits.
Many financial institutions will allow the funding of these types of accounts it is as simple as opening a bank account. This could be at a local bank or a significant financial institutions like Fidelity (NYSE: FNF), TD Ameritrade (NASDAQ: AMTD), Charles Schwab (NYSE: SCHW), etc.
What Is The Difference Between UGMA And UTMA Accounts?
The Uniform Gifts to Minors Act is abbreviated as UGMA, and the Uniform Transfers to Minors Act is abbreviated as UTMA. Both UGMA and UTMA account holders are "custodians," and while they may send money into the account for the benefit of the minor, the money is handled solely by the custodian. Typically, the money is released to the child when they reach the age of maturity.
What Distinguishes UGMA And UTMA Accounts From 529 Plans?
In a few crucial ways, 529 plans differ from UGMA/UTMA accounts:
- UGMA/UTMA funds can be used for anything that helps the kid, whereas 529 plans can be used only for educational expenditures.
- The individual who started the account owns and controls the 529 plan with UTMA/UGMA accounts, the money is passed to the recipient at the age of majority.
- Custodial funds, unlike 529 plans, are considered the child's property, which means they count for a larger proportion in financial assistance calculations.
Some parallels exist between the two types of plans:
- Both sorts of accounts are custodial accounts, which can be utilized to benefit a child.
- Anybody can contribute to either account type there are no income-based limits.
If you have a medium to long-term view, a UGMA/UTMA account or a 529 account is typically preferable to placing your money in a low-interest savings account. Remember that you can have both a 529 plan and a UGMA/UTMA account for the same kid.
Why You Should Open A UGMA/UTMA Account For Your Children
Unlike a 529 plan, funds in a custodial account are not required to be utilized only for higher-education costs. The custodian has the authority to withdraw funds from a UGMA/UTMA custodial fund for any expenditure that benefits the kid, such as technology, transport, accommodation, or any other expense for the child.
The most significant advantage of UGMA/UTMA custodial accounts is their adaptability. You may utilize the money in the bank even if your child does not choose to attend college because it can be used for a variety of costs. While profits in a UGMA/UTMA account are not tax-free like in a 529 plan, they are tax-advantaged differently.
A guardian can opt to include their child's unearned wealth with their own tax return, based on how you file your tax return. Unearned revenue is income that does not come from work, such as interest or investments. In 2020, the first $1,100 of a child's unearned income can be claimed tax-free on the guardians' tax return, with the remaining $1,100 taxed at the child's tax rate, which is likely to be significantly lower than their parent's.
UGMA/UTMA Accounts Can Help With College Expenses
One of the biggest benefits of opening a UGMA/UTMA account is that it allows parents to save money for their children's education without paying taxes on capital gains. If you open an investment account for your child and fill it with stocks or bonds, there will be no tax consequences if you sell those investments once your child turns 18 and uses them toward college expenses.
The only catch is that withdrawals made by your child must be used exclusively for qualified higher education expenses such as tuition, fees, books, and room and board at an eligible educational institution under Section 529 plans.
Things To Be Aware Of While Dealing With UGMA Or UTMA Accounts
A UGMA/UTMA custodial account might make a lot of sense if you want to save funds or transfer assets to your children for a range of expenditures other than schooling. One thing to keep in mind is that a UGMA/UTMA account is only linked to one identified beneficiary. Unlike a 529 plan, in which you can transfer assets to a sibling or other beneficiary, any unused funds in a UGMA/UTMA account must be spent or dispersed by the time the kid reaches the age of majority or their state's limit age for custodial accounts.
Final Thoughts
Investing in stocks, bonds, and mutual funds is a great way to build wealth, but there are other ways too. UTMA accounts are a good way to save for children's future education, particularly if you plan to send them to a private school or college. Use it wisely, though savings for college can be used for more than tuition, including books and supplies, room and board, and even studying abroad.
Related: 10 Ways to Teach Your Kids How to Make Better Financial Decisions