Saving For College with UTMA/UGMA’s

The Uniform Transfers To Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA) are two laws that, combined, give us the term “UTMA/UGMA”, perhaps the most indecorous acronym in college financial planning.  Yet UTMA/UGMA’s are a useful tool for those seeking to reduce their tax liability while accumulating assets for a college education.

First came UGMA, which was introduced in 1956 and revised in 1966 as a means of transferring assets from parents to their children. Under UGMA rules, assets such as securities were placed in an account in the name of a minor, obviating the need to establish a trust. This made the accounts subject to special tax treatment. However, states varied widely in their rules for these accounts. The UTMA was established to set uniform standards for the handling of gifts-to-minorswithin the proven legal framework of trusts and custodianship.

The UTMA is a more flexible extension of the UGMA that allows gifts to be real estate and other tangible property. It was recommended by the National Conference of Commissioners on Uniform State Laws in 1986 and was subsequently enacted by most U.S. states. States that had UGMA laws, with the exception of South Carolina and Vermont, repealed UGMA and replaced it with the UTMA. The UTMA stipulates that contracts that refer to the UGMA are now governed by UTMA rules.

The UTMA provides a mechanism under which gifts can be made to a minor without requiring a third party to be the minor’s guardian. It satisfies the IRS qualifications for the gift tax exclusion in 2023 of $17,000 per individual or $34,000 for a married couple. If an individual has multiple children, he or she can gift $17,000 to each of their children. Likewise, a couple can gift $34,000 to each child. Since it is updated annually based on inflation, a family may assume that the tax exclusion will rise to $18,000 per individual and $36,000 per couple in 2024 and to $19,000 per individual and $38,000 per couple in 2025.

UTMA allows the donor of the gift to transfer title to a custodian who will manage and invest the assets until the minor reaches a certain age. The donor, usually a parent or grandparent, can also be the custodian. It’s not necessary to transfer the management of the account a third party, but that may be done if advantageous from a tax perspective.

The age of maturity of the minor beneficiary is 21 in most states, but a few set it at 18. Prior to maturity, the custodian can make payments for the benefit of the minor’s education. These are drawn from the assets in the account. The value of remaining assets will be included in the donor’s gross estate if the donor dies while serving as custodian.

At the age of maturity, an UTMA account is owned by the minor beneficiary, who assumes control of the account. The age at which the assets transfer to the beneficiary in the 50 states and the District of Columbia is noted in Table A, along with the date upon which UTMA replaced UGMA.

Table A:

UTMA Age Of Maturity By State

Prior to 1986, the UGMA allowed assets in the account to be taxed at the minor’s income tax rate. Since then, a tax law known as the “Kiddie Tax” has reduced the tax savings available through UGMA/UTMA’s. The Kiddie Tax was created as part of the Tax Reform Act of 1986 to prevent parents from shifting income-producing assets into a child’s name to take advantage of the child’s lower tax rate. Under the current Kiddie Tax rules, the first $1,250 of a child’s unearned income qualifies for the standard deduction, the next $1,250 is taxed at the child’s income tax rate, and all unearned income above the threshold of $2,500 is taxed at the parent’s marginal income tax rate.

The value of the assets withdrawn in any given year is considered a student-owned asset, which is assessed at 50% for FAFSA purposes. This means that the student’s eligibility for financial aid is reduced by 50% of the value of the assets withdrawn while the student is in their senior year of high school or is in college. To avoid this negative impact on aid eligibility, a viable strategy is to deplete the assets in the account while the student is in  high school by spending for the benefit of the student’s education on such expenses as summer courses, educational camps, college tour packages, test-prep courses and books, computer equipment, and other eligible expenses. This would reduce or eliminate the diminution of the amount of financial aid that the student is eligible to receive.