How do UGMA accounts work?

Parents or guardians who want to start saving and investing for their children may consider opening a Uniform Gifts to Minors Act (UGMA) account. While UGMA accounts let you save for your child’s future, there are tax considerations and other limitations to keep in mind.

Here’s how UGMA accounts work and what you need to know to help you decide if this type of account is right for you.

UGMA accounts defined

A UGMA account is a type of custodial account that allows you to gift money and financial securities like stocks, bonds and mutual funds to minors.

Typically, parents or guardians open these accounts for their children, but anyone can open and fund a UGMA account on behalf of a minor.

As the custodian, you manage the account for the minor’s benefit until the minor reaches their age of majority, or the age at which they’re considered an adult in their state. Once the minor reaches this age, they take full control of the account.

It’s important to note that gifts in a UGMA account are irrevocable and belong solely to the minor. Once they take control of the account, the minor can use the money however they want.

Gifts in a UGMA account are exempt from federal taxes up to $15,000 annually. Beyond this amount, the minor — not the custodian — is responsible for paying taxes at their individual tax rate.

Key takeaways:

• The custodian manages the account, but the minor owns it.
• Gifts can include money and financial securities like stocks, bonds and mutual funds.
• The first $15,000 is exempted from federal taxes, and the minor is responsible for paying taxes on any amount beyond this.

UGMA vs. UTMA accounts: What’s the difference?

The Uniform Transfer to Minors Act (UTMA) is an expansion of the UGMA and allows the custodian to transfer any kind of property to the minor. In addition to the cash and securities permitted under UGMA, UTMAs can include risky assets and tangible assets such as real estate or fine art.

Like UGMA accounts, the first $15,000 in a UTMA account is exempt from federal taxes.

UGMA account benefits and drawbacks

UGMA accounts have several pros but also a few cons to consider.

How are UGMA accounts taxed?

Gifts up to $15,000 a year are exempt from federal taxes. Beyond this amount, the minor will have to pay taxes according to their individual tax rate.

Realized earnings are also subject to taxes but are taxed according to the ”kiddie tax” rules.

• The first $1,100 is tax-free.
• The next $1,100 is taxed at the child’s tax rate.
• Any amount over $2,200 is taxed at the parent’s tax rate.

3 steps to open a UGMA account

Follow these steps to open a UGMA account:

1. Choose a provider. Banks or brokerages can open a UGMA account. Compare things like fees, available assets and minimum opening deposit requirements.
2. Open an account. Complete an application by providing any necessary information. This typically includes personal information such as your and the minor’s name, dates of birth and Social Security numbers.
3. Fund the account. Provide an account number and routing number from an external bank or brokerage account to transfer assets.

Investing not popular with kids

While the majority of parents (68%) said they gave their kid an allowance, none reported that their kids were investing those funds.

Bottom line

A UGMA account is only one type of custodial account that allows you to save money and invest on a minor’s behalf. You control the account and investments until the minor becomes an adult. When they turn 18 or the age of majority in their state, they take full control of the account.