What Is an UGMA Account? A Guide to Understanding and Using It

Saving for a child’s future is one of the most thoughtful and impactful gifts you can offer. Whether you’re a parent, a financial advisor, or someone looking for the perfect long-term gift, you may have come across the term “UGMA account.” But what exactly are UGMA accounts, and how do they work?

This guide will walk you through the essentials of UGMA accounts, from how they function to their benefits and considerations, so you can make informed decisions about using them as a financial tool.

What is an UGMA Account?

UGMA stands for the Uniform Gifts to Minors Act, which allows adults to set up a custodial account for a minor. These accounts enable parents, guardians, or gift-givers to transfer financial assets—such as cash, stocks, or bonds—to children without needing to create a formal trust.

The primary purpose of an UGMA account is to provide a straightforward, cost-effective way to gift assets while ensuring the funds are held and managed for the child’s benefit until they reach the age of majority (usually 18 or 21, depending on the state). Upon reaching this age, the minor gains full control over the account.

How Does an UGMA Account Work?

UGMA accounts are relatively simple in structure. Here’s how they operate:

1. Custodian Control

A designated adult—often a parent or guardian—is appointed as the custodian. The custodian is responsible for managing the account until the child reaches the age of majority. They can make investment decisions and withdrawals, but funds must be used solely for expenses that benefit the minor.

2. Ownership by the Minor

While managed by the custodian, all assets in an UGMA account legally belong to the child. This means it is not an asset of the parent or custodian, which could have implications for financial aid and taxes.

3. Transfer of Control

Once the child reaches the state’s designated age of majority, they gain complete control of the account. This allows them to use the funds however they choose, for purposes such as education, purchasing a car, or starting a business.

Benefits of an UGMA Account

UGMA accounts offer several notable advantages, making them a popular choice for financial planning and gift-giving. Here are the top benefits:

1. Simple Setup and Low Cost

Unlike trusts, UGMA accounts are straightforward to create and involve minimal administrative costs. They don’t require the legal fees or complexities associated with setting up a formal trust, making them an appealing option for many families.

2. Flexibility in Contributions

UGMA accounts allow for a wide range of assets to be gifted, including:

• Cash
• Stocks
• Bonds
• Mutual funds

This provides flexibility in tailoring contributions to the child’s future needs and financial goals.

3. Tax Benefits

While UGMA accounts do not offer direct tax-deferred growth like 529 plans, they still provide some tax advantages. A portion of the earnings will be taxed at the child’s lower tax rate under the “kiddie tax” rules, reducing the overall tax burden.

4. Teaches Financial Responsibility

One unique advantage of UGMA accounts is that they hand responsibility over to the minor upon reaching adulthood. This early exposure to financial assets teaches the child valuable lessons about managing money and making smart investments.

5. No Usage Restrictions

Unlike college savings plans (e.g., 529 plans), funds in UGMA accounts aren’t limited to educational expenses. The child can use the money for any purpose once they gain control, making UGMA accounts more versatile.

Key Considerations When Setting Up an UGMA Account

While UGMA accounts are beneficial, there are a few factors to keep in mind before setting one up:

1. Loss of Control

The custodian manages the account only until the child reaches the age of majority. After that, the child gains full access and can use the funds as they wish—whether or not it aligns with the original intent.

2. Impact on Financial Aid

Because UGMA accounts legally belong to the child, they are considered the child’s asset when calculating financial aid. Assets in the child’s name have a greater impact on financial aid eligibility compared to assets owned by parents.

3. Tax Risks Under the Kiddie Tax

While the kiddie tax can reduce the tax rate for investment income, it only applies up to a certain limit. Any earnings beyond the tax threshold ($2,500 for 2023) will be taxed at the parent’s rate, potentially raising the tax liability.

4. Irrevocable Nature

Contributions to UGMA accounts are irrevocable. This means once assets are transferred, they cannot be reclaimed or redirected for other purposes. It’s crucial to carefully consider how much you’re comfortable gifting before making deposits.

UGMA vs. 529 Plans: What’s the Difference?

Parents and gift-givers often find themselves deciding between an UGMA account and a 529 college savings plan. Here’s a quick comparison to help you evaluate your options:

Steps to Open an UGMA Account

If you’ve decided that an UGMA account is the right fit for your needs, follow these steps to get started:

1. Choose a Financial Institution: Select a bank or brokerage that offers custodial accounts. Compare fees, investment options, and services to find the best match.
2. Appoint a Custodian: The custodian will manage the account. This is typically a parent or guardian.
3. Fund the Account: Transfer cash, stocks, or other financial assets into the account. Keep in mind that gifts are subject to the annual gift tax exclusion limit ($17,000 for 2023).
4. Select Investments: Work with the custodian to choose investment vehicles that match the financial goals of the account, such as mutual funds or ETFs.
5. Monitor and Manage: Regularly review and manage the account to ensure it aligns with the child’s future needs.

Final Thoughts on UGMA Accounts

UGMA accounts present a wonderful option for transferring assets to a child in a tax-efficient manner without the complexities of a formal trust. They offer flexibility, teaching opportunities, and room for financial growth, making them a popular choice among parents, financial advisors, and generous gift-givers alike.

If you want to give a child a financial head start or build a meaningful gift, UGMA accounts are well worth considering. Be sure to weigh their benefits against your financial goals and speak to a financial advisor for personalized advice.