A minor cannot typically receive any assets under the law. If you were planning to leave money or an inheritance to your young child as part of an estate plan, you might consider opening an UTMA account.
The Uniform Transfers to Minors Act (UTMA) allows an adult to transfer assets to a minor by opening a custodial account for them. This type of account is managed by an adult — the custodian — who holds onto the assets until the minor reaches a certain age, usually 18 or 21.
Custodial accounts for minors are commonly used to save for college, and the benefit of an UTMA account is that you can transfer assets to a child without creating a trust, which could be more challenging and expensive to open. However, UTMA accounts have their own rules regarding how funds are spent and taxed.
How does an UTMA account work?
An UTMA account is easy to open and straightforward to use.
An adult opens the UTMA account and contributes to it on behalf of a minor beneficiary.
The custodian manages the account until the minor comes of age.
All custodial assets transfer to the UTMA beneficiary.
You can use an UTMA accounts to invest in typical securities, like stocks, bonds, mutual funds, and ETFs. These accounts can also hold life insurance policies and real estate property, as well as other assets like royalties, patents, and fine art.
The custodian is responsible for managing the UTMA account and any of its investments, similar to how a trustee manages a trust. The custodian can be the donor (the person who opened or donated to the account), another adult (like a grandparent), or a financial institution.
UTMA vs UGMA
UTMA expands upon an older law called the Uniform Gifts to Minors Act (UGMA), which restricted the types of assets a custodial account could hold. Each state sets their own inheritance laws — all states but one (South Carolina) have replaced their UGMA statutes with UTMA ones.
Beneficiaries receive assets in an UGMA account at age 18, which is not always the case with UTMA accounts.
Transferring an UTMA account
Generally, the UTMA account transfers to the beneficiary when they become a legal adult, which is usually age 18 or 21, but it can be later.
The age of adulthood may be defined differently for custodial accounts, like UTMAs or 529 plans, depending on your state. (Sometimes you may see this referred to as the age of trust termination.) For example, in New York a child becomes a legal adult at age 18, but for custodial accounts the age of legal adulthood is 21.
In some states, you may be able to extend the custodian’s control for a few more years and delay the age at which your child receives the assets even further. If you want more control over when a beneficiary receives assets and how they are used, then you might consider a trust, which can cover more situations and be tailored to yours.
What can UTMA funds be used for?
The custodian can spend or invest the money in the UTMA account at their discretion, as long as it’s for the minor’s benefit. This covers a wide range of expenses, including education, transportation, and extracurricular activities like music lessons or summer camp for the beneficiary.
Saving for college with UTMA accounts
Many people might consider an UTMA account to help save for their child’s higher education costs. However, UTMA accounts do not let you control how the beneficiary uses the funds once they become an adult. That means if you opened an UTMA account for your child to help save for their higher education, there is nothing stopping them from using the college savings on something else once they have access to the funds.
Additionally, if your child is applying for federal financial aid, the money in the UTMA account will count against them, making it harder to qualify for needs-based loans or scholarships.
If you want an account to hold and invest assets exclusively for higher-education costs, then you might consider a 529 college savings plan.
How is an UTMA account taxed?
UTMA accounts have a few tax implications. While there are no taxes on withdrawals (since contributions are made with after-tax dollars), there may be taxes on any unearned income.
Unearned income includes taxable interest, dividends, and capital gains on any assets in the account.
Since the passage of the Tax Cuts and Jobs Act in 2017, a minor’s unearned income over $2,100 is taxed at the rate of estates and trusts. This is sometimes called the “kiddie tax.”
The 2023 tax brackets for estates and trusts are:
$2,900 to $10,550
24% on the amount over $2,900 plus $290
$10,550 to $14,450
35% on the amount over $10,550 plus $2,126
37% on the amount over $14,450 plus $3,491
Depending on the circumstances, like if the child is a full-time student, parents might be able to claim their child’s income on their own tax return. Sometimes this might result in a higher tax burden. If you have tax concerns, you might consult with a tax advisor who better understands your situation.
Prior to the Tax Cuts and Jobs Act, UTMA accounts were taxed differently. A portion of earnings were subject to income tax at the child’s tax rate (often zero) and then additional earnings were taxed at the parent’s rate.
When someone gives a gift to someone else during the year, they may have to pay taxes if the gift exceeds the gift tax exclusion. The gift tax exclusion is $17,000 in 2023. Any contributions you make over this limit — including contributions to an UTMA account — are subject to the gift tax.
Furthermore, the gift could count towards the estate tax exemption and make it more likely that your estate will have to pay taxes.