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Saving For College, Part 8: UGMA/UTMA Custodial Account

Contributed by mm | January 4, 2005 2:28 PM PST

UGMA/UTMA Custodial Account (Uniform Gifts to Minors Act/Uniform Transfers to Minors Act) is not an investment vehicle specificially geared toward college saving needs, although it is used by some for the exact purpose of college saving.

How It Works

By setting up and contributing to UGMA/UTMA accounts, parents (or other donors) can transfer certain assets to child's name while keeping control of the account until the child reaches the age of Majority. Such transfers are considered irrevocable gifts to the minor in whose name the account is registered.

Pros:

- Scale: Under the annual federal gift-tax exclusion, each donor may generally make gifts of $11,000 per year, per child without federal gift-tax consequences and there is no income restriction. As multiple donors can contribute to the same beneficiary in the same year, it should be relatively easy to establish big balance in UGMA/UTMA accounts.

- Flexibility In Fund Usage:If used by the custodian before the child reaches the age of majority, use must be for benefit of the child. In other words, you can use the balance to pay for day care or even diaper.

Cons:

- Limited Tax Advantage: The tax advantage associate with UGMA/UTMA is income from those accounts is reported as child's income and usually taxed at a lower rate. However, UGMA/UTMA does not allow tax deferred or tax-free growth as provided by both 529 Plans and Coverdell ESA.

- Less Favorable Financial Aid Treatment: UGMA/UTMA account is treated as child's assets and is subject to a higher contribution percentage in financial need calculation.

- Lack of Control: UGMA/UTMA account balance becomes child's assets once he/she reaches the age of majority (varies by state). Unlike 529 Plans and Coverdell ESA, you cannot change the owner of UGMA/UTMA accounts once the gift is made.

Under the annual federal gift-tax exclusion, each donor may generally make gifts of $11,000 per year, per child without federal gift-tax consequences.

My Personal Take

UGMA/UTMA Custodial Account might not be the best college saving tool for most of us as it lacks key features in both 529 Plans and Coverdell ESA. Nevertheless, UGMA/UTMA can still be a good tax tool if used wisely.

Now that we've discussed 529 Savings Plan, 529 Prepaid Tuition Plan, Coverdell ESA and UGMA/UTMA Custodial Account, in the next episode we will take a look at how other retirement saving tools like 401(k) or Roth IRA can be engineered to fit into the college saving picture.

(This article is a component of the 10-part "Saving for College" series at PFBlog. If you want to read from the start, follow the links at this Table of Contents page.)

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