UGMA / UTMA accounts are considered the granddaddy of college savings accounts.   Parents were successfully using these accounts to accumulate significant amounts of money for their children’s college before Section 529 plans and Coverdell ESA’s. The UGMA (Uniform Gift to Minor’s Act) and UTMA (Uniform Transfer to Minor’s Act) are nothing more than custodial accounts. A custodial account is used to hold and protect assets for a minor until they reach the age of majority in their state. These accounts are often used to take advantage of the “kiddie tax because the assets are considered the property of the minor. The kiddie tax allows a certain amount of a minor’s income to go untaxed, and an equal amount to be taxed at the child’s tax rate (as opposed to mom and dad’s rate). A custodial account is ideal for a parent or grandparent who isn’t worried about the assets going to the child if unused, wants greater investment options than a Section 529 account, may want to use the money for pre-college education or expenses, is not worried about getting “needs” based financial aid, wants to lower their eventual estate by using their annual gift tax exclusion and wants to lower their taxes on a couple thousand dollars in annual investment income.


These accounts are extremely flexible aside from the requirement to hand over “control” of any remaining money to a child at 18 or 21. When to spend it on the child, it ’s basically up to the custodian (usually the parent) to determine how to invest the money. Use of this account can help (but not guarantee) that $850 of investment income will go untaxed each year, with another $850 being taxed at the child’s tax bracket. The same tax benefit that makes custodial accounts attractive can also make them unattractive.  Excess income is fully taxed at a parent’s marginal tax bracket after the first $1,700 in income potentially being sheltered from taxes. This would not occur in a Section 529 plan or a Coverdell ESA. The account requires a custodian to hand over control of the assets to the child at anywhere from age 18 to 21, depending on the state in addition to this. A strained relationship may present a problem while parents with a good relationship with their child might be able to coerce those assets into being spent on college. Lastly, a custodial account counts heavily against a student’s financial aid application, since it is ultimately considered an asset of the child. Custodial accounts allow typical stock, bond, and mutual fund investments. They are not permitted ownership of higher risk investments like stock options or buying on margin due to their custodial and protective nature. One of the important misconceptions about these accounts is that they guarantee that you will not pay income tax on a certain amount of dividends, interest, and gains. Although simply take advantage of it, the reality is, custodial accounts don’t actually grant this privilege.