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If you're looking for ways to save and invest money for your child's future, you've probably come across UGMA and UTMA accounts. These custodial accounts have been around for decades and remain popular options for parents who want to build wealth for their kids.

But popularity doesn't always equal the best choice for your situation.

UGMA and UTMA accounts come with some distinct advantages, but they also have limitations that catch many parents off guard. Before you open one of these accounts, you need to understand exactly how they work and what happens when your child becomes an adult.

Let's break down everything you need to know about these custodial accounts so you can make an informed decision.

What Are UGMA and UTMA Accounts?

UGMA stands for Uniform Gifts to Minors Act, while UTMA stands for Uniform Transfers to Minors Act. Both are types of custodial accounts that allow you to transfer assets to a minor without setting up a formal trust.

These accounts were created to simplify the process of giving financial gifts to children. Before these laws existed, transferring significant assets to minors required creating complex trust structures that came with legal fees and ongoing administrative costs.

Here's how they work in practice.

You open the account as the custodian (usually a parent or grandparent) for the benefit of a minor child. You manage the investments and make decisions about the account until the child reaches the age of majority in your state, which is typically 18 or 21.

The key word here is "irrevocable." Once you transfer money or assets into a UGMA or UTMA account, that money legally belongs to the child. You can't take it back or change the beneficiary.

The Difference Between UGMA and UTMA Accounts

While UGMA and UTMA accounts function similarly, there are some important differences you should understand.

UGMA accounts, which came first, are more restrictive in what they can hold. They're limited to financial assets like cash, stocks, bonds, mutual funds, and insurance policies.

UTMA accounts were developed later and offer more flexibility. They can hold everything a UGMA account can hold, plus additional assets like real estate, patents, royalties, fine art, and other tangible property.

The timing of when control transfers to the child can also differ. UGMA accounts must transfer at the age of majority in your state (usually 18). UTMA accounts may allow you to extend the custodianship until age 21 or even 25 in some states, depending on state law.

Not all states have adopted UTMA legislation. Some states only allow UGMA accounts. If you live in one of these states, you won't have the option to open a UTMA account.

For most parents focused on saving cash and investments for their children, the distinction between UGMA and UTMA won't matter much. The functional differences only become relevant if you're planning to transfer non-financial assets.

The Pros of UGMA and UTMA Accounts

Let's start with the advantages that make these accounts attractive to many families.

Simple to Set Up and Manage

You don't need a lawyer to establish a UGMA or UTMA account. Most brokerage firms and banks offer these accounts, and you can open one in less time than it takes to file your taxes.

There are no setup fees, no annual filing requirements, and no complicated paperwork. You simply designate yourself as custodian, name the child as beneficiary, and start contributing.

No Contribution Limits

Unlike 529 plans or Coverdell ESAs, UGMA and UTMA accounts have no annual contribution limits. You can deposit as much as you want, whenever you want.

This flexibility can be valuable if you receive a windfall, sell a business, or simply want to make large contributions without worrying about IRS restrictions.

Flexible Use of Funds

The money in these accounts can be used for any purpose that benefits the child. College tuition, summer camp, a car, starting a business, or a down payment on a home are all fair game.

This stands in contrast to 529 plans, which are specifically designed for education expenses and come with penalties if you use the money for non-qualified purposes.

Potential Tax Benefits

A portion of the investment earnings in UGMA and UTMA accounts are taxed at the child's tax rate, not yours. For many families, this results in tax savings.

The Cons of UGMA and UTMA Accounts

Now for the drawbacks that often surprise parents who didn't fully understand what they were signing up for.

Complete Loss of Control at Age of Majority

This is the big one. When your child reaches the age of majority (18 in most states, or up to 21-25 if your state allows extended custodianship for UTMA accounts), they gain complete legal control of the account.

You have no say in how they use the money. None.

If your 18-year-old wants to withdraw the entire balance and spend it on a luxury car or a trip around the world, they can do that. If they want to invest it all in crypto or hand it to a questionable friend with a "business idea," they can do that too.

Most parents don't think this will be an issue with their child. But circumstances change, and even responsible teenagers can make poor decisions when suddenly handed significant wealth.

Negative Impact on Financial Aid

UGMA and UTMA accounts are considered the child's assets for financial aid purposes. This creates a major problem for families hoping for need-based aid.

The Free Application for Federal Student Aid (FAFSA) assesses 20% of a student's assets as available for college costs each year. By comparison, only up to 5.64% of parent assets are considered available.

Let's put this in numbers. If you've built up $100,000 in a UGMA account for your child, the FAFSA will expect $20,000 of that to be used for the first year of college. If that same $100,000 was in a 529 plan owned by the parent, only $5,640 would be counted.

That difference can cost your family tens of thousands of dollars in lost financial aid over four years of college.

Irrevocable Transfer

Once you contribute money to a UGMA or UTMA account, you can't get it back. The money permanently belongs to the child.

If your financial situation changes and you need that money, too bad. If you have a falling out with your child, you can't redirect the funds to a sibling.

This lack of flexibility can become a serious problem if life doesn't go according to plan.

Complicated Tax Reporting

While the potential tax benefits can be attractive, the actual tax reporting can be complex, especially once your child's unearned income exceeds certain limits.

You may need to file Form 8615 (Tax for Certain Children Who Have Unearned Income) along with your child's tax return. If your child is required to file their own return due to the account, you'll need to handle that as well.

No Creditor Protection

Assets in UGMA and UTMA accounts offer no protection from creditors. If your child gets sued or faces financial difficulties as a young adult, the account can be targeted by creditors.

UGMA, UTMA, and the Annual Gift Tax Exclusion

One benefit of UGMA and UTMA accounts is how they interact with federal gift tax rules.

Each year, you can give up to a certain amount per person per year without triggering gift tax reporting requirements. This is called the annual gift tax exclusion. If you're married, you and your spouse can each give an amount up to the annual exclusion per child per year.

Contributions to a UGMA or UTMA account count toward this annual exclusion. This makes these accounts useful tools for high-net-worth families looking to reduce their taxable estate while transferring wealth to the next generation.

It's worth noting that the money must be an irrevocable gift to the child. You can't use UGMA or UTMA accounts as a temporary parking spot for your own money while claiming gift tax benefits.

The custodian can spend the money on the child's behalf for things that benefit the child, but you can't simply withdraw it back for your own use. That would violate the irrevocable nature of the gift and could create gift tax issues.

How UGMA and UTMA Accounts Affect College Financial Aid

We touched on this earlier, but it's worth exploring in more detail because the financial aid impact is one of the most significant downsides of these accounts.

The FAFSA uses a specific formula to calculate your Student Aid Index (SAI), which determines your eligibility for need-based aid. Assets in the student's name are weighted much more heavily than assets in the parents' names.

Here's the breakdown. Student assets (including UGMA and UTMA accounts) are assessed at 20%. Parent assets are assessed at a maximum of 5.64%. Retirement accounts, home equity, and certain other assets aren't counted at all.

Let's look at an example. Suppose you have two families, each with $50,000 saved for their child's education.

Family A put the money in a UGMA account. The FAFSA will expect $10,000 of that to be available for the first year of college.

Family B put the money in a 529 plan owned by the parent. The FAFSA will expect $2,820 to be available for the first year.

That's a difference of $7,180 in expected contribution for just the first year. Multiply that over four years, and the family with the UGMA account could be looking at nearly $30,000 less in financial aid eligibility.

For families who expect to qualify for need-based aid, this difference can be detrimental to college funding plans.

Alternatives to UGMA and UTMA Accounts

Given the limitations of UGMA and UTMA accounts, many families are better served by alternative strategies.

529 College Savings Plans

529 plans are the most popular alternative, and for good reason. They offer tax-free growth when used for qualified education expenses, and they're treated as parent assets on the FAFSA.

The main limitation is that the money must be used for education. However, recent changes have expanded what qualifies, including K-12 tuition, apprenticeship programs, trade schools, and student loan repayment.

Starting in 2024, unused 529 funds can also be rolled over to a Roth IRA for the beneficiary under certain conditions, providing an exit strategy if the child doesn't need all the money for education.

Unlike UGMA and UTMA accounts, you maintain complete control of a 529 plan. You decide when and how the money is distributed, and you can change the beneficiary to another family member if needed.

Coverdell Education Savings Accounts

Coverdell ESAs work similarly to 529 plans but with lower contribution limits ($2,000 per year per child) and income restrictions on who can contribute.

ESAs are not very common anymore because they typically aren't as flexible as 529s, but it is an option worth mentioning.

Roth IRAs (in Parent's Name)

Some families use Roth IRAs as a creative college funding vehicle. You can withdraw your contributions (not earnings) from a Roth IRA at any time without taxes or penalties.

If your child doesn't need the money for college, it continues growing for your retirement. If they do need it, you have access to your contributions. Once your Roth IRA has been open for five years, you can also withdraw the earnings penalty-free for qualified education expenses.

Roth IRAs don't count as assets on the FAFSA if they're in the parent's name, giving you better financial aid treatment than a UGMA or UTMA account.

The downside is that you're limited to the annual Roth IRA contribution limits, as well as potential income limits that could reduce or disqualify your eligibility.

Taxable Investment Account in Your Name

You could simply keep the money in your own name in a regular taxable brokerage account. Yes, you'll pay taxes at your rate rather than the child's rate, but you maintain complete control.

You can always gift money to your child later when they're mature enough to handle it responsibly. Or you can use it for their benefit on your own timeline.

This approach provides maximum flexibility and doesn't impact financial aid as severely as a UGMA or UTMA account.

Trust Funds

For families with substantial assets, establishing a trust provides much more control than a UGMA or UTMA account. You can set specific terms for when and how distributions are made, often well into the child's adulthood.

Trusts require legal assistance to set up and may have ongoing administrative costs, but they offer far more protection and control over the assets.

Should You Open a UGMA or UTMA Account?

The answer depends on your specific situation and priorities.

UGMA and UTMA accounts make the most sense for families who meet these criteria:

• You're certain you won't qualify for need-based financial aid, so the FAFSA impact doesn't matter
• You want maximum contribution flexibility without annual limits
• You trust your child to handle money responsibly when they reach adulthood
• You want to transfer wealth out of your taxable estate
• You want the simplicity of an easy-to-open account without ongoing maintenance

UGMA and UTMA accounts are probably not the best choice if:

• You might qualify for need-based financial aid
• You're not comfortable giving your 18-year-old complete control of potentially significant assets
• You want to maintain control over how and when the money is used
• You're primarily saving for education and want the tax benefits of a 529 plan

For most middle and upper-middle-class families, a 529 plan offers a better combination of tax benefits, financial aid treatment, and parental control. The flexibility to change beneficiaries and the recent expansion of qualified expenses have addressed many of the historical concerns about 529 plans.

That said, there's no rule that says you can only use one strategy. Some families maintain both a 529 plan for education and a smaller UGMA or UTMA account to teach their children about investing and money management with real dollars.

Even better, consider using both a 529 and a parent-owned individual brokerage account for more flexibility.

There is more than one option for saving for your child's future. As always, the best combination of investment vehicles is going to depend on your specific situation.

Frequently Asked Questions About UGMA and UTMA Accounts

What happens to a UGMA or UTMA account if the child dies before reaching the age of majority?

If the child passes away before taking control of the account, the assets become part of the child's estate. Typically, the assets would pass according to state intestacy laws, usually to the parents. However, estate settlement procedures would need to be followed.

Can I transfer a UGMA or UTMA account to a 529 plan?

Yes, but with limitations. You can liquidate a UGMA or UTMA account and use the proceeds to fund a 529 plan for the same beneficiary. However, the 529 plan must remain a custodial account for that child. You cannot change the beneficiary, which limits some of the flexibility that makes 529 plans attractive. You'll also need to pay any capital gains taxes on appreciated assets when you liquidate them.

Who pays taxes on UGMA and UTMA account earnings?

The child is responsible for taxes on earnings in the account. The account uses the child's Social Security number, and investment income is reported on the child's tax return (or the parent's return in some cases for young children). The kiddie tax applies to unearned income above $2,700 (in 2026), meaning that amount is taxed at the parents' marginal rate.

Can grandparents open a UGMA or UTMA account for their grandchildren?

Yes. Any adult can serve as custodian and open these accounts for a child. Grandparents commonly use UGMA and UTMA accounts as part of their estate planning strategy to transfer wealth to grandchildren while taking advantage of the annual gift tax exclusion.

What's the difference between a custodian and a trustee?

A custodian manages a UGMA or UTMA account on behalf of a minor and must act in the child's best interest, but the account terminates automatically when the child reaches the age of majority. A trustee manages a trust, which can have much more complex rules and can extend well into the beneficiary's adulthood or even their entire life. Trusts offer far more control but require legal setup and ongoing administration.

Can I use UGMA or UTMA money to pay for my child's basic expenses?

This is a gray area. Custodians can use account funds for the child's benefit, but you cannot use the money to pay for expenses you're already legally obligated to provide as a parent. Basic food, clothing, and shelter typically fall into this category. However, enrichment activities, education expenses beyond what's required, and other items that benefit the child are generally acceptable. When in doubt, consult with a tax professional or attorney.

What investment options are available in UGMA and UTMA accounts?

Investment options depend on where you open the account. Most brokerage firms offer the full range of investments available to regular investors, including individual stocks, bonds, mutual funds, and ETFs. Some banks offer UGMA and UTMA savings accounts or CDs with limited investment options. UTMA accounts can also hold real estate and other tangible assets, though this requires more complex administration.

Can I change the beneficiary of a UGMA or UTMA account?

No. Once you designate a child as the beneficiary, that cannot be changed. The money irrevocably belongs to that child. This is fundamentally different from a 529 plan, where the account owner can change the beneficiary to another qualifying family member.

Do UGMA and UTMA accounts have required minimum distributions like retirement accounts?

No. There are no required distributions from UGMA or UTMA accounts. The custodian manages the account until the child reaches the age of majority, at which point the now-adult child has complete control but no requirement to take distributions on any particular schedule.

What happens if the custodian dies before the child reaches the age of majority?

A successor custodian takes over management of the account. Some states allow you to name a successor custodian when you open the account. If no successor is named, state law typically provides a process for appointing one, often another parent or family member. The account continues for the benefit of the child regardless of the custodian's death.