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Educational Funding: UTMA/UGMA Accounts

UTMA/UGMA Accounts

Custodial Accounts
With the latest tax cut, custodial accounts—known as Uniform Gifts or Transfers to Minors Act accounts—now deserve a second look. The new, lower capital-gains tax rate means that most kids pay only a 5% tax on any gains in their stock portfolio. You have more flexibility to spend the money for expenses other than college tuition (as long as it's spent on behalf of the child), and you have a broader choice of investments than in 529 plans and even Coverdells. Potential drawbacks: Kids get control of the accounts once they become adults, and distributions can hurt your chances of getting financial aid.

Uniform Gifts vs. Uniform Transfers
The Uniform Law Commissioners adopted the Uniform Gifts to Minors Act (UGMA) in 1956. The primary focus then was to provide a convenient way to make gifts of money and securities to minors. Later, it became clear that a more flexible law was desirable. The Uniform Law Commissioners adopted the Uniform Transfers to Minors Act (UTMA) in 1986. UTMA expands the types of property you can transfer to a minor, and provides that you can make other types of transfers besides gifts. Nearly all states have adopted UTMA, but sometimes people still refer to the Uniform Gifts to Minors Act because they're used to that name. For our purposes it doesn't matter which law prevails in your state because the essential principles of both acts are the same.

A transfer to a child under UTMA or UGMA requires the involvement of a custodian. This is an adult who will manage the property until the child reaches the age when control passes to the child. The person transferring property to the child can act as custodian or name another adult to act in that capacity. The custodian manages the property, making decisions concerning buying and selling, reinvesting earnings and so forth. The custodian may also take money from the account to spend for the benefit of the child.

It's important to understand the following: property held in a custodial account
is owned by the child. Even though the child will not have control of the property until later, the child is the owner as soon as property is transferred to the account. This fact has important consequences: A gift is legally complete when cash or other property is transferred to a custodial account, not when the account terminates. You aren't allowed to change your mind and take the property back. Income generated by assets in the account is the child's income. (If you abuse the account, you can be taxed on the income, however.)

The account terminates when the child reaches a specified age. The age depends on your state's law, and may depend on the type of transfer. In some states you can choose to designate a different age than the one that automatically applies, but the law will impose a limit on the age you can choose. When the account terminates, the custodian transfers the property to the child, who can use it in any way he or she chooses.

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