If you have children or plan on having children, you may already be worrying about the costs of raising them. Plus, you may want to help them get a leg up in life. But have no fear, there are quite a few financial decisions you can make right now. An example of that would be to set up a UGMA account.
Ready to start saving for your kids? A UGMA account might be the way to go…here’s why.
What Is A UGMA Account?
First, what is a UGMA account? UGMA stands for The Uniform Gifts to Minors Act, and it was developed in 1956. The account allows people to give or transfer their assets to underage beneficiaries. In other words, a parent can transfer their assets to their children.
With a UGMA account, the amount given to the beneficiary isn’t taxed via the gift tax, up to a certain amount.
The account works just like any other custodial account. The donor (in this case, the parent), can be the custodian. They will manage the account on behalf of the beneficiary (the child). You can open a UGMA account through a bank or other brokerage institution.
Besides you, other family and friends can contribute to the account as well. There are no contribution or income limits. So, if you want to have a gift that keeps on giving, you can ask for money to your child’s account during times like their birthday or Christmas.
Usually, UGMA accounts (and whatever money is saved) is then used for education purposes, like college costs. But, unlike other accounts like 529 plans, there are no penalties if money is withdrawn for other expenses.
Once the beneficiary reaches the age of majority (this is state dependent), they are then granted access to their account to manage on their own. They can then use the money for whatever they please.
Pros & Cons of the UGMA Account
As with anything, there are pros and cons to these types of accounts. Let’s talk about them.
Pro: No Gift Tax
There is no gift tax for contributions up to a certain amount when it comes to UGMA accounts. In other words, the gift giver does not have to pay taxes for contributions up to $15,000 per individual (as of the 2021 tax year). This means more money in your pocket.
Con: Some Income Is Taxed
While a UGMA account may be appealing for those who are looking to gift money, it doesn’t work exactly the same for the beneficiary. Remember, the minor or beneficiary is considered the owner of all assets in a UGMA account. If that account generates any income, those earnings can be taxed.
However, there is a slight pro to this (depending on your outlook). As long as the child is a minor, the account and earnings can be taxed to the parent or the child. If you choose to have the income taxed to the parent, you can take advantage of the “kiddie tax”.
In other words, if the UGMA accounts earnings were less than $2,200 (for 2020 and 2021), and the child was no older than 19 (or 24 if they’re a full-time student), at the end of the tax year, the parents of the child can then report that income on their own tax return. Because of that, the first $1,100 of the child’s income would be tax-free. And then the next $1,100 would be taxed at the child’s tax rate vs. the parent’s. Anything after that is taxed at the parent’s tax rate.
Keep in mind that if you choose to have your child claim the income, they will then have to file a tax return.
Any money put in a UGMA account is considered an irrevocable gift. In other words, once the money is in the account, the donor can not take it out. This can be a pro for the beneficiary. They won’t have to worry about people changing their minds and dipping into the account.
Con: Financial Aid Will Be Affected
Because custodial accounts are considered assets of the child, they are counted against financial aid. If you expect that your child will want to attend college, keep in mind that based on their UGMA account, they may not qualify for other grants or loans through financial aid.
Pro: The Account Can Be Extra
If you think your child will attend college, you may be wondering if a UGMA account is the best savings option. While the account is a great way to give your child extra money, you can also use it in addition to a 529 plan or Roth IRA (when they start working). This will help you save more money for college, without being taxed on the UGMA account.
Con: Can Cause Strain
Many parents want the best for their children. But, with a UGMA account, the child gets to spend the money as they see fit once they reach a certain age. In other words, even if you expect and want your child to go to college and use the money in the account for that, they don’t have to. They may want to blow the money on a Las Vegas vacation, and you wouldn’t be able to stop them.
While this is extremely rare, it is worth noting that some parent’s and their children have strained relationships because of a lack of communication and expectations about the money in the UGMA account.
Pro: Fewer Penalties
One of the best pros to a UGMA account is that there are zero withdrawal penalties. The beneficiary can withdraw their money, for any expense, without paying an extra fee if the expense would be deemed “ineligible” (like with 529 plans).
Many major banks offer UGMA accounts, all you have to do is ask!
Is a UGMA Account Right For You?
Now that you know what a UGMA account is and the pros and cons, you can decide if it’s right for you.
While there are many pros to a UGMA account, there are a few cons that need to be considered as well. However, if opening an account works for your family financially, it can set your child up for life!
What do you think? Will you start a UGMA account for your children?
AUTHOR Kimberly Studdard
Kim Studdard is a strategy consultant and course launching expert. When she isn't spending time with her daughter and husband, or crying over This Is Us, you'll find her teaching other mompreneurs how to scale their business without scaling their workload.