UGMA & UTMA

In our next article in our series of custodial accounts we take a look at the eligibility rules, contribution rules, withdrawal rules and leftover funds when it comes to custodial accounts such as the UGMA and the UTMA. For those of you who need more details of both Uniform Transfer to Minor’s Act (UTMA) and Uniform Gift to Minor’s Act (UGMA), read the detailed overview of UTMA & UGMA. Also next, read about the advantages and disadvantages of UGMA and UTMA.

When it comes to UGMA/UTMA accounts the good news is that there are no real restrictions. At least not any restrictions that directly pertain to the accounts themselves. There are advantages and disadvantages to contributing more or less to a single UGMA/UTMA account. But the UGMA/UTMA act itself does not set any true restrictions.

UGMA and UTMA Eligibility Rules

The eligibility of a donor to set up and establish a UGMA/UTMA account is only limited by the restrictions of the institution where they wish to open the account itself. Most institutions will allow any donor to establish an UGMA/UTMA account for any named minor without regard to the relation between that donor and the minor. The institution will normally insist that the donor provide them with the birth date and social security number of the minor. There are times when a social security number will not be required, but because the gains on the account will be taxed to the minor, the account will be subjected to backup withholding if their is no social security number provided. The institution will allow the donor to designate their own name as custodian but they will need to have some contact information for the designated successor custodian. The donor will also need to specify an age where any funds that have not been distributed by the custodian for the benefit of the minor, are distributed directly to the minor. If the donor wishes to establish an account and not be the primary custodian, most institutions will require the primary custodian to be present on establishment of the account.

UGMA and UTMA Contribution Rules & Restrictions

There are not any true contribution rules or restrictions for a UGMA/UTMA account. All the donor needs to understand is that once the money is given, it cannot be taken back. There is no regard for the intent of the donation. The money must be used for the benefit of the minor until they reach the age of majority. As long as that condition is met, the funds cannot be restricted in any other way. This means that a contribution can never be retrieved by the donor if they feel the money is being wasted on a wayward child. Contributions are also subject to Federal as well as State tax rules. This means that you need to be aware of the tax implications of any contributed funds to a UGMA/UTMA account. These tax implications may affect the donor as well as the minor for whom the account is set to benefit.

UGMA and UTMA Withdrawal Restrictions

Withdrawals from the UGMA/UTMA accounts are subject to a single restriction. They must be made for the benefit of the minor. This is a vague description and the interpretation of which has been litigated repeatedly across the United States. My suggestion is that if the money is being withdrawn, that the custodian make certain they can document the way in which the money was used specifically for the minor in whose name is on the account. If the custodian plans to take the whole family on vacation and claim it was for the benefit of the minor, they may have a problem. The same thing applies if they take everyone out for a meal, the question of whether the funds went strictly for the benefit of the minor or not could be litigated. In the end, the custodian needs to make certain that all withdrawn funds from a UGMA/UTMA are documented as being used specifically for the minor.

Leftover funds that have not been distributed by the custodian for the benefit of the minor become accessible directly by the minor when they reach the age that was first designated on the establishment of the account. This means that they can walk into the bank on their birthday and pull out all of the money. I suggest that if all of the money has not yet been used, that it be transferred to some other type of custodial account for the benefit of the minor before they reach the designated age.

Advantages of UGMA and UTMA

The primary advantage of the UGMA/UTMA accounts is simplicity. The standardization of the rules, regulations, and guidelines for the transfer made custodial accounts accessible to everyone. Even the low income grand parent that simply wanted to put away $25 per week into a college fund for their grandchildren, a fund the parents could not touch, has access to a legal vehicle without hiring a lawyer. The donor would simply instruct their banker to set up the account, they would name a custodian and successor custodian, an age when the minor could receive funds not already distributed and everything was set. Prior to the UGMA/UTMA accounts, setting up a custodial account like this was something that only those of means could afford.

The secondary advantage to UGMA/UTMA accounts is that the assets that are in the name of the UGMA/UTMA trust are taxed as assets of the minor. This is advantageous because under most circumstances the minor is paying less in taxes than the donor. Therefore it is an advantage for a donor to put the money into a UGMA/UTMA account. For example, say the donor wishes to assist the minor in buying a home one day, if that donor begins saving and investing for the minor in a UGMA/UTMA account the account will grow faster because it will be taxed at a lower rate than if it were held solely by the donor.

A third advantage to a UGMA/UTMA account is that the funds in the account are sheltered from lawsuits and seizures that are made against the custodian or donor. This means that without the UGMA/UTMA designation, if the donor had a savings account that they intended to go to the minor in the future, and they had an asset seizure, the funds would be gone. But if the funds were held in an UGMA/UTMA account, the funds would be sheltered from that seizure.

Disadvantages of UGMA and UTMA

The primary disadvantage of the UGMA/UTMA account is control. There are many reasons why people want to save for the benefit of others. Maybe a donor wishes to save for a minor’s college education, a down payment on a home, or even for a wedding. But with the UGMA/UTMA accounts there is no way to designate the purpose of the money. Therefore if the donor wishes to pay for college, yet the child does not wish to go to college, with the UGMA/UTMA accounts the money will still belong to the minor. The same thing applies if the money is meant for a home, but the minor wishes to go on a vacation with the funds, there is nothing that the donor can do if the child has already reached the age of majority, as specified on the establishment of the UGMA/UTMA account.

This lack of control is also psychological and will decrease the amount of money that the donor may set aside for the child. If a donor knows that they can retrieve some funds in case of an emergency they will more aggressively put money into a custodial account. If they know every time they donate to the account they can never again touch the funds, they will more than likely contribute to the account less frequently. It is a simple matter of human nature, there is a difference between setting aside money that you can take back, and giving it permanently. If you know you can get it back, you will set aside more money, more frequently.

UGMA and UTMA Overview

The Uniform Transfer to Minor’s Act (UTMA) and Uniform Gift to Minor’s Act (UGMA) were acts of congress that were designed to give individuals a way to set aside assets for minor’s until they reach the age of adulthood. The differences between the two are minimal and have to do with the way in which each state adopted the congressional act. For most purposes the names, UGMA/UTMA can be used interchangeably. There are some contracts that refer specifically to UGMA accounts. But if these contracts are used in UTMA states, the law permits UGMA to be defined as UTMA. In other words, if you are in a state that adopted UTMA, then even if your contract states UGMA, it is an UTMA contract. The point is one for lawyers really, the fact is that for most uses, each act, UGMA or UTMA, operate in the same manner and have the same guidelines and rules.

Though the acts cover all types of assets the primary way that most people encounter UGMA/UTMA is when they are dealing with bank accounts. These bank accounts became popular because it was a way to transfer assets to the minor and allow the gains on the accounts to be taxed at the minor’s tax bracket. These accounts also became popular as a way for individuals to set aside money, for the future benefit of the minor, that was legally protected from being used in any other manner. This way the donor could be assured that the money would not be used by the custodian of the funds for any other purpose.

Advantages and Disadvantages of UGMA and UTMA

When an asset is transfered to an UGMA/UTMA the donor must appoint a custodian for the account as well as name the minor for whose benefit the asset is being held. At this time the donor is also oftentimes asked to name the successor custodian in case the original named custodian is unable to perform their duties. This naming of the successor custodian gives an assurance to the donor that the even if the first named custodian is not able to perform their duty, the next custodian is still someone that they can trust.

The advantage to this overall arrangement is that the donor does not need to hire an attorney or go through any legal procedure other than transferring the proper ownership of the asset to the UGMA/UTMA account. This makes it simple to transfer assets to a minor, in a custodial account, and allows the donor an assurance that the transfer is legal and standardized. Once the asset is transferred it is then taxed to the minor. This is an advantage because normally,the minor is in a lower tax bracket than the donor.

There are several disadvantages to this overall arrangement and has caused some donors to move to other types of custodial accounts when transferring assets to minor’s. The first disadvantage is that the donor loses full control of the asset. This loss of full control can lead some donor’s to be hesitant to transfer assets to the minor. This is a problem when the accounts are set up for purposes such as a college education for the minor. The loss of total control of the asset is also a concern for the donor because they may want the funds used for a specific purpose, and if it is not used for that purpose, they want the funds returned. For example, if the donor wanted the minor to use the funds for college or a first home, they cannot pull the money back if the minor wishes to use it for a different purpose. Whereas in other types of trusts, money can be set aside for specific purposes and withdrawn if it is not used for that purpose.

UGMA & UTMA – Eligibility Rules, Contribution Rules, Withdrawal Rules and Leftover Funds

Anyone that wishes to transfer an asset to a minor using UGMA/UTMA tilling can do so without restriction. But there are consequences to the transfer if it surpasses certain limits. If the asset is larger than the allowable gift tax, then the donor’s contribution will be taxed. If the contribution surpasses other limits, there will be a consequence. You need to consult your tax advisor for federal as well as for the state the donor lives in and the state where the minor lives.

Withdrawals can be made for any purpose that is for the benefit of the minor. These withdrawals need to be documented by the custodian. The custodian must always be able to justify any withdrawal that they have made from a UGMA/UTMA account that they control. It is advisable that they keep very good records, this is not difficult, but is a necessary step that the custodian must take.

Unused and Leftover funds in a UGMA /UTMA account are supposed to be distributed to the person for whom the account was first set up to benefit. When the donor first opens the account they specify the age at which they wish the minor to receive full benefit of the asset. This is normally 18, 21, or 25. When the minor reaches that age, any leftover funds are distributed to their name.

Overall the UTMA/UGMA accounts are simple ways to transfer assets for the sole benefit of a minor. The process is simple and straightforward and there are no complicated decisions to be made or complicated paperwork to handle. Of course everyone wants an exception to the standardized UGMA/UTMA rules and this has led to a large number of similar asset transfer vehicles, each of which cater to the particular concerns of the donor. These hybrid UGMA/UTMA custodial accounts can be obtained from any broker or tax advisor. In the end it all depends on the donor’s specific intent in giving the funds as well as how much control they wish to give to the minor and when they wish that control to be transferred. But if you prefer simplicity, and if you wish to give to a minor, the UGMA/UTMA accounts are the easiest method to use.