UTMA Accounts Explained: Rules, Custodial Brokerages and More

Parents, grandparents and others who wish to invest in the future of a child they love are often drawn to the idea of opening UTMA custodial brokerage accounts to provide a financial head start.

UTMA accounts, named for the Uniform Transfers to Minors Act that governs them, offer a tax-advantaged way to gift assets to minors without the expense of setting up a trust. (And by the way, UTMA is pronounced “ut-muh.”) Money contributed to an UTMA is exempted from gift tax, up to a maximum of $15,000 in contributions per year. And income earned on the contributed funds is taxed at the tax rate of the minor who is being gifted the funds.

When recipients reach adulthood (typically at the age of 21, but it varies by state), they can use the money for anything they want. Please note, your adult child may not choose to spend the money how you see fit. It’s now their money.

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UTMA assets can be used for college costs, and that’s one common goal. But the funds also could be used to pay for a trip to Europe, a wedding, a honeymoon, a down payment on a home…or a Corvette.

Flexibility gives UTMA accounts an advantage over some other savings strategies, such as 529 plans and Coverdell Education Savings Accounts (ESAs), which can be used only for qualified education expenses.

Another difference: An UTMA account can hold more than just cash and securities. Gifts to the account also may include real estate, paintings, royalties and patents.

But there are restrictions on UTMAs that can make them less appealing than they may at first appear.

Many families are surprised to learn that under the Uniform Transfers to Minors Act, any gifts made to this type of account are irrevocable.

A custodian (a parent or other adult) manages the account in the minor’s interest until he or she reaches legal age, but the child is the owner of the account. And there are no takebacks. Trying to maneuver around this restriction could result in potential legal action against the custodian by the child.

Why would anyone want to cancel an UTMA account once it’s established?

It could be the family has run into unexpected financial hardship and the parents need the money to pay medical or other bills. They may have had more children and want to evenly divide among them the assets they put in the UTMA account. Or they might be worried the recipient, though legally an adult, isn’t as mature as they had hoped they would be (at least about money) and will mismanage the account.

Or perhaps, like many families, they realize a bit late that an UTMA account is considered the child’s asset, not the parents’, when it comes to getting financial aid for college and could limit the amount of college grants their student may receive. Receiving less in grants often leads to more student loans, both for the student and for the parents.

I spoke with a couple recently who had the opposite experience. They set up an UTMA account for the purpose of paying for their child’s college education — but he received a full scholarship and doesn’t need the UTMA money for college. The couple now would like to use the assets in the UTMA account to bolster their retirement savings. Unfortunately, with an UTMA, they can’t simply call a do-over and withdraw the money, because it’s not theirs.

What can families who want to cancel an UTMA account do?

If possible, you may want to start by having a heart-to-heart discussion with the child whose name is on the account, so there aren’t any surprises or hard feelings down the road about the changes you may decide to make.

It’s also a good idea to work with an attorney, financial adviser and/or tax professional who is well-versed in the rules that govern UTMAs to ensure that any moves you make are legal.

One option these professionals will likely suggest is to transfer the funds in the UTMA to another type of account that’s better suited to your goals. For example, if you’re worried your child won’t spend the UTMA money on college costs as intended, or that the money in the UTMA will affect the child’s status when applying for financial aid, you could move the funds to a 529 account, which can be used only for educational expenses.

As a “qualified tuition plan,” a 529 offers its own tax breaks. And the money saved is credited to the parent on financial aid forms, not the minor, so this type of account has a smaller impact on the amount of federal aid the child can receive.

Another alternative might be to use a substitution strategy — swapping any spending done for the child (above and beyond expenses normally paid by parents, such as shelter, food and clothing) for funds from the UTMA account. An UTMA custodian has the authority to withdraw and spend money for the benefit of the child who owns the account.

But it’s important to note that custodians have a fiduciary role, which means they must responsibly manage the assets with the child’s best interests in mind. That may be a complex concept to stick to, so it can be helpful to talk to a professional about any past or potential expenditures you plan to reimburse from the account.

And, of course, you’ll want to keep complete records and hang on to all receipts. If an unhappy adult child can make a reasonable legal case that you breached your duty as a custodian and decides to pursue it, you could end up in court.

If your child has reached the legal age to take over management of the account and you’re worried about where the money will go when that happens, you may decide to offer an incentive to keep things on track.

You could suggest signing over the UTMA assets to another account that’s in both of your names, such as an annuity or a Family Limited Partnership (FLP), with the assurance that there will be a reward in the future — perhaps in the form of a larger inheritance from your estate.

But this strategy, too, can be tricky, so prudent parents will want to work with a knowledgeable professional. The rules for these accounts vary from state to state, and it’s critical that the changes you make are legal and that the language is clear.

Of course, another way to avoid any potential problems with an UTMA account is to work with an attorney, financial adviser and/or tax professional from the start, to be sure your savings and investing strategy is the right fit for the child you love … and for your whole family.

Kim Franke-Folstad contributed to this article.

Appearances on Kiplinger.com were obtained through a paid PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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