If you’ve thought about opening a bank account or investment account for your child, you may have come across the term “UTMA,” which stands for “Uniform Transfers to Minors Act.” The UTMA is a law that has been enacted by most states, and allows for the transfer of property to a minor without the appointment of a guardian (a few states still follow the older Uniform Gifts to Minors Act, which is similar but has more restrictions on the types of property that can be transferred). Under the UTMA, the gifted property is managed by a custodian until the minor reaches a certain age, generally 18 or 21.
If you open a bank account or investment account in your child’s name, it will likely be in the form of a UTMA, with you as the custodian. But before you go out and open an account, here are a few things you should know about UTMAs:
There are no contribution limits. Therefore, you can give your child as much money as you want. Other people can also contribute to UTMA accounts, such as grandparents and other relatives and friends. However, the gift tax does apply, so you should keep in mind that the annual gift tax exclusion limit for 2014 is $14,000 per person. In other words, you may have to pay tax on gifts worth more than $14,000. However, if you are married and file a joint tax return, you and your spouse can gift one person up to $28,000 without paying the gift tax. You can also give up to $14,000 to each of your children (or up to $28,000 if the gift is from you and your spouse).
Unearned income, such as interest and dividends produced by UTMA assets, may be subject to income tax, pursuant to what’s commonly called the “kiddie tax.” The good news is that the first $1,000 earned by property held in a child’s name is not taxed, and the next $1,000 is taxed at the child’s tax rate. But the bad news is that any amount over that initial $2,000 threshold will be taxed at the parent’s tax rate (rather than the child’s rate, which is typically lower). However, there would have to be a substantial amount of property in a UTMA in order to generate income of more than $2,000, so taxes may not be a concern for most parents. The kiddie tax applies to children under 19 years of age, as well as older children up to 24 who meet certain requirements. The purpose of the kiddie tax is to prevent parents from trying to avoid having to pay taxes by transferring property to their children so the income would be taxed at the child’s tax rate.
Gifts are irrevocable. Once assets are part of a UTMA, they can only be used for the benefit of the child (which does not include your basic legal, parental obligation to support your child with necessities like food, clothing and shelter). Therefore, you should not transfer assets to a UTMA that you may want to use for your own purposes later. However, a bank account established as a UTMA for monetary gifts from relatives and friends can be a great way to teach a child about personal finance and money management.
UTMA assets can hinder your child’s financial aid award. Assets in custodial accounts are considered to be assets of the child during the financial aid evaluation process. Your child’s assets are assessed at a higher percentage than yours. That means the amount your family is expected to contribute to your child’s education expenses will be higher if the assets are held in a UTMA than if they were held in your name, and the assets in the UTMA are considered available to help pay for your child’s education.
When your child reaches the age specified by your state, he gets control of the account. In most states, the custodial arrangement terminates when a child reaches age 21 (though in some states, it is age 18). At that time, your authority as custodian ends, and the account belongs solely to your child. If your child is immature for his or her age, this may not be an optimal situation, as he or she will be able to withdraw and spend any money, liquidate investments, or otherwise dispose of assets without your permission.
Opening a UTMA account is fairly straightforward and easy at most banking and investment institutions. You will just need your child’s social security number, in addition to the usual information required to open a new account.