UTMA Custodial Accounts

I received the following message from my cousin a couple of days ago :

[REDACTED] was gifted $100. Of course she doesn’t get the value. Instead of blowing it all on Barbie I was thinking about trying this whole investing thing. What would you recommend?

The UGMA, or Uniform Gift to Minors Act, was passed in the 1950s as a financial vehicle for families that wanted to build and pass along generational wealth to their children, but it was limited to stocks and bonds. UTMA, or Uniformed Transfer to Minors Act, is an updated version of the Act which was passed in the 1980s, and expanded the types of assets that could be contained within the account, which now includes real estate, stocks, bonds, annuities, and life insurance. Not all states have adopted UTMAs (see South Carolina and Vermont), so you’ll see the terms UTMA and UGMA used interchangably. Once the child or beneficiary reaches the age of majority, normally around the age of 18 (depending on the state), they would then take ownership of the account.

The reason why our family chose UTMAs over a 529 Plan (another investment vehicle for minors), is because the 529 can only be used for educational expenses, or else a penalty is applied. If our child is gifted money or receives an inheritance, we can manage the money on her behalf in the custodial account. If our daughter obtains a scholarship which pays for or drastically reduces her college tuition, she can use the UTMA however she sees fit. We also have the flexibility to move the funds from the UTMA to a 529, since the UTMA will be counted as income if/when she decides to apply for financial aid. Given that she’s still a toddler, we have plenty to time to both grow the account and bestow our knowledge of personal finance upon her as the years progress. Otherwise, she can always refer to this blog to learn how to manage her money. Hopefully, YNAB is still around at that time.

If you’re looking into opening a custodial account, there are a couple of things to keep in mind. UTMA/UGMA accounts are taxable accounts, where realized income may be subject to taxes. The IRS exempts the first $1100 of passive gains from the account as of 2021, gains in access of this amount are taxed at the child’s tax rate, roughly around 10-12%. Gains over $2200 are taxed at the parent’s tax rate, which prevents parents from dodging taxes by placing assets in their children’s accounts.

Our daughter’s UTMA holds a single position, VOO, which is Vanguard’s Fortune 500 Exchange Traded Fund, which contains the largest 500 countries in the US Market as tracked in the S&P 500 Index, and includes companies such as Apple, Microsoft, Amazon, Tesla, Facebook/Meta, Nvidia, and Berkshire Hathaway. As the market cap of these companies change, they will adjust automatically without our intervention. That’s one of the many benefits of investing into an index.

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