There are a number of ways to save money for a family's children that will release the money to them at an early age in their life.
The two most popular options are either through the Uniform Gift to Minors Act (UGMA) or through the Uniform Transfer to Minors Act (UTMA). Both of these were created with a similar goal, to save money for children to use when they become legal adults. While the acts are similar, both have specific nuances that must be taken into account.
Under both acts, a grandparent or a parent usually serves as the custodian for the child. This person is usually whoever has legal custody of the child. The custodian is the person who donates funds into the account and also manages it. A custodian must be someone who is a US citizen and is currently in a financially sound position. Additionally, any other adult can invest in these accounts on behalf of a minor.
Both of these accounts are taxed to the minor beneficiary for the account's interest and dividends. The custodian can withdraw from this account at any time without any restrictions so long as the money is used to benefit the child in some way. This rule is not strictly enforced, and as an example may allow a parent to buy a car the child can use when he or she turns 16. This gives a custodial account an edge over 529 plans or other education savings accounts because it allows the custodian to withdraw the money. However, a custodian is not allowed to close the account.
The two types of accounts do differ in some key ways. In Florida, the termination age for a UGMA trust is 18 years, while the termination age for a UTMA trust is 21 years. The termination age for both of these acts differ by state so it is important to consult an attorney who is familiar with the state's law.
Another way the accounts differ is in the type of assets that can be held in the account. The UGMA account is limited to gifts and transfers to bank deposits, securities, mutual funds, and insurance polices. A UTMA account is not as restricted, and allows the transfer of any kind of asset including real estate.
One difference between a custodial account and educational savings plan is how they are taxed. UGMA and UTMA accounts are taxed as ordinary income and are not tax free like an ESA or 529 plan. Once the child turns 14, both the income and capital gains in the custodial accounts will be taxed at the child's rate.
The good news is there is some tax relief for children under 14. The first $950 deposited into a custodial account is tax-free. The next $950 is taxed at a child's rate, and any additional funds are taxed at the parent's rate.
Parents who want to use a custodial account to save for a child's education should note the child is not required to use these funds for college. Once the child takes control of the account, the child may use the money for any purpose they desire. Children who start college before the account termination may still use the account's funds for tuition as long as the custodian consents.
UGMA and UTMA accounts do not provide the same level of asset protection or flexibility that a trust can provide. Often parents and grandparents use a combination of