By Randy Neumann
What’s wrong with the UGMA? Plenty. UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) are ugly acronyms – and poor planning vehicles as well – so why not turn ‘em in for a new model? But first, a short lesson in government and history.
States, in these United States, are supposed to have “uniform” laws among them. Does that mean that each state’s legislature is smart enough to pass the same laws at the same time? Not really. It works as follows: There is a group of lawyers, judges and law professors known as the National Conference of Commissioners on Uniform State Laws that proposes model legislation. Then, it’s up to the individual states to determine whether they’ll adopt them and what changes they’ll make. This is where the horse-trading takes place to placate various special interest groups.
UGMAs were first introduced in 1956 and were adopted by all the states shortly afterward. They were created to provide a convenient way to make gifts of money and securities (stocks, bonds and mutual funds) to minors for college funding. In 1986, UTMAs, which expand the types of property you can transfer to a minor, replaced UGMAs. (Since most people still refer to them as UGMAs, I’ll use that name for both).
You can think of these vehicles as “a poor man’s trust.” They are available from various financial institutions – banks, brokerage houses, et al. at no cost. UGMAs are similar to trusts in that both place property under the control of a person who isn’t the beneficial owner – that is, the person who has the ultimate right to enjoy the fruits of the property. In the case of a trust, a trustee manages the property for the benefit of the beneficiaries. In the case of a custodial account, the custodian manages the property for the benefit of the minor.
Yet custodial accounts are not trusts. In fact, the whole point of UGMA and UTMA is to permit you to transfer property to a minor without establishing a trust. The legal framework for trusts is much more elaborate than for custodial accounts. Generally speaking, trusts are more expensive (usually costing a few thousand dollars), more complicated, and more timeconsuming than custodial accounts. Because UGMAs are not trusts, they have some undesirable features. The first is, when the child reaches “majority,” which is between 18 and 21 years of age depending on the state, the money becomes the child’s. So, that hard-earned and wisely invested money earmarked for the child’s education can wind up in a sports car dealer’s account.
The second problem with UGMAs is the taxation. If the child is under age 14, the first $950 of unearned income is tax-free. Earnings from $951 to $1,900 are taxed at the child’s income tax rate. Earnings over $1,900 are taxed at the parent’s rate. For a child aged 14 or over, all income is taxed at the child’s rate.
The third problem with UGMAs is in the estate possibilities. If the custodian (say, the father of the child) dies while acting as custodian, the entire account balance is included in the custodian’s estate. If, to avoid this result, the father names his spouse (the mother) as custodian and she dies at a time when state law imposes upon her the duty to support the child (most often after the father’s death), the account balance may be included in her estate as well.
What is the solution to the UGMAs problems? There are two. One is to set up a trust. Such a trust might be a Minor’s Trust, which is a creature of the Internal Revenue Code Section 2503(c). It has many advantages over UGMAs. First, you can name yourself as the trustee. The trust can be authorized to invest in virtually any prudent investment. The trustee can loan to and borrow from the trust at adequate interest rates and even retain the right to change the trustee within.
However, since it will cost you a few thousand dollars to set up (and more to maintain) this trust, you really need to be able to contribute a lot of money to make it worthwhile.
Another solution is a Section 529 college savings plan. It also gets its name from the Internal Revenue Code because this is a federal law and it has several advantages over UGMAs. The first is in taxation. If you use the money for a child’s college expense, there is no tax on gains in the account. Unlike an UGMA that becomes the child’s property at age 18, a 529 plan does not. A 529 plan cannot be included in the donor’s estate nor is it considered an asset of the child for financial-aid calculations.
Further advantages of a 529 plan over an UGMA include the ability for the donor to change the beneficiary or to take money out of the plan. Lastly, you can convert an UGMA into a 529 plan. Please consult your legal advisor prior to taking action.
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 and securities and insurance offered through LPL Financial. Member FINRA/ SIPC. He can be reached at 600 East Crescent Avenue, Suite 104, Upper Saddle River, NJ 07458, 201-291-9000.