UNIFORM GIFTS TO MINORS ACT (UGMA)
The Uniform Gifts to Minors Act (UGMA) also called the Uniform Transfers to Minors Act (UTMA) in some states, is simply a way for a minor to own securities. The UGMA/UTMA setup is commonly used to give monies to a minor. IRS regulations allows a person to give many thousands of dollars per year to any other person with no tax consequences. If the recipient is a minor, the UGMA/UTMA provides a way for the minor to own the assets without involving an attorney to establish a special trust. When giving assets to a minor using a UGMA/UTMA, the donor must appoint a custodian. The account is managed by a custodian who should not be a parent- otherwise the income will be taxed to the parent. Investments are usually restricted by your state to life insurance, cash and certificates of deposit. Gifts may be given to the trust under the $11,000 per person per year exclusion - even to the use of life insurance.
These were the accounts that were used extensively in the past. You put dollars in the account under the child’s name with you as custodian. You control the money until the child is 18- 21, but all income generated is taxed immediately to the child, at the child’s lower rate. These accounts are currently not my favorite funding vehicle. The good news is that, subject to the kiddie tax, the income earned should generate little to no tax liability to the child, depending on the size of the account. The bad news is that the dollars belong to the child. At age 18 or 21 depending on the state, he/ she can take the dollars and spend them at their discretion. They need never be used for college. If I’d had access to big bucks at age 21, I would have had a great year; a new car etc. But, I clearly wouldn’t have a whole lot of the cash left at age 22. Another drawback is that unearned income over $1,300 per year is still subject to the Kiddie Tax Rules.
In cases where the funds are actually turned over to the child, the actual savings throughout the years could backfire when, under financial aid formulas, the student may be required to contribute 35% of savings while the parents percentage as required by the colleges might be only 6%.
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