The acronyms and numbers that are associated with custodial accounts for minors can get a bit confusing. One of them is the UGMA account, and this stands for the Uniform Gifts to Minors Act. It was originally recommended in 1956, and it was revised 10 years later.
This is an account that is set up to benefit a minor, and there is an adult custodian that will manage the account. If you establish a UGMA account for your child or grandchild, you can act as the custodian, but you can alternately empower someone else to assume the role.
There is no limit to the amount that can be transferred into the account each year, but there is a gift tax consideration. The first $16,000 that is transferred into the account by any one person is not subject to the gift tax, but anything above that amount would trigger gift tax exposure.
However, in addition to the $16,000 per year exclusion, there is also a $12.06 million lifetime gift and estate tax exclusion. As a result, unless you are in possession of assets that exceed this amount, the gift would not be taxed, but you would be required to file a gift tax return.
A UGMA account can hold cash, securities, and life insurance policies. You contribute into the account with after-tax earnings, so withdrawals of the principal are not taxed at all. The first $1150 in untaxed earnings can be distributed tax-free, and the next $1150 will be taxed at the child’s rate.
Withdrawals that exceed $2300 would be taxed at the account creator’s rate. The age at which the child can directly access the assets is 21 in Illinois, but it is just 18 in many states. When the child reaches the age of 21, the account must be terminated.
Assets in the account can be used for any purpose that benefits the child, and this would include college tuition. However, the assets will be looked upon as the property of the child, and this would have a negative impact on student aid applications.
In 1987, the Uniform Transfers to Minors Act was enacted, and Illinois and most states in the union recognize UTMA accounts at this point. The details are the same across the board with one major difference: Any type of property can be held by a UTMA account.
Section 529 Savings Plans
If your objective is strictly dedicated to college savings, a Section 529 savings plan will be a better choice. There is a major tax advantage over the other types of custodial accounts because the earned income will not be taxed at all if it is used to pay for approved education expenses.
Assets in the account are considered to be the property of the parent or grandparent that establishes the account, and this is beneficial from a student aid perspective.
You permanently surrender assets that you deposit into a UGMA or UTMA account; they become the property of the child. This is not the case with a 529 savings plans. If you want to remove money from the account for your own purposes, you have the freedom to do so.
Prior to the enactment of the Tax Cuts and Jobs Act of 2017, assets in this type of account could only be used to pay for approved college expenses. A provision in this measure allows for the utilization of $10,000 annually to cover elementary and secondary school expenses.
Need Help Now?
If you have already determined that you should work with a Naperville or North Aurora estate planning lawyer to put a plan in place, we can help. You can send us a message to request a consultation appointment, and we can be reached by phone at 630-568-8611.