By Randy Neumann
Do you have a child or a grandchild who owns an UGMA (Uniform Gift to Minors Act) or an UTMA (Uniform Transfer to Minors Act)? If you do, you might want to review it.
Giving gifts to children is neither a novel nor a contemporary idea. Back in 1956, the National Conference of Commissioners on Uniform State Laws (a group that tries to get the states to make laws that are similar; after all, we are a Republic) proposed a law regarding gifts of securities (stocks and bonds) to minors. Interestingly, the law was sponsored by the New York Stock Exchange and the Association of Stock Exchange Firms. Later, the law was broadened to include gifts of money.
Giving gifts to children through UGMAs can have multiple benefits. The child can see their assets grow, and some, but not all, of the taxes are paid at the child’s (usually lower) tax bracket. However, there are drawbacks, as well. Once you make a gift, it belongs to the child – you can’t take it back. Additionally, at the age of majority (which is 18 in New Jersey), the word that starts with a C, “college,” can change to another word that starts with a C, “Corvette.”
There also are estate-planning issues with UGMAs. If you are the custodian of the trust, at your death the value of the UGMA becomes part of your estate because you retain the power to determine how your gift will be applied for the benefit of the child. An easy fix for this is to name someone else as custodian.
Another potential problem is income tax. It is your legal obligation to support your child (assuming you claim them as a dependent). If you use the income from the UGMA to satisfy this obligation, the IRS can make a case that the income is taxable to you and not your child.
Also, if the child dies before receiving the account, the asset will pass according to state law, which may not be what you would want, especially if the child has siblings. The way to solve this problem is to pay a few bucks and have a lawyer draw a trust with more flexibility than what is provided by UGMAs.
Lastly, if you are using an UGMA to fund a college education, don’t.
There are myriad reasons why 529 plans are better for funding college education than are UGMAs and UTMAs. Let’s begin with student aid. Most student-owned investments, e.g., UGMAs and UTMAs, must be reported on the federal aid application, the FAFSA, and are factored into the expected family contribution at the relatively high rate of 35%.
However, under recent changes in the financial aid laws, student-owned 529 plans are not reportable and have no impact on the child’s eligibility for federal aid. And parent-owned assets, including 529 plans, are factored in for financial aid purposes on a sliding scale, with a maximum of 5.64%.
The next consideration is tax benefits. I ran some numbers comparing a $10,000 investment in a 529 plan to that of an UGMA for a 1-year-old who would begin college at age 18. The difference came out to be several thousand dollars. Why the big difference? Taxes.
The money in the UGMA is taxable annually, and the money in the 529, if used for higher education, is not.
So, if you want to trade in your clunker, UGMA, for a new model, a 529 plan, you will have to cash in the UGMA account because 529 plans cannot accept securities. But take heart because, as Yogi Berra in his AFLAC commercial said, “Cash is just as good as money.”
Here are a couple of other housekeeping details you should know about. The 529 will keep some of the attributes of the UGMA account. The money still belongs to the child, not the custodian, and will be available to the child at the age of 18.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann CFP is a registered representative with securities and insurance offered through LPL Financial. Member FINRA/SIPC. He can be reached at 12 Route 17N, Suite 115, Paramus, 201-291-9000.
