How to Pay for Your Child’s College Education with UTMA Accounts

How to Pay for your Kids' College with UTMA Accounts

When it comes to planning for their child’s financial future, parents are presented with a vast array of options. But, transferring property to minors can create a number of problems for parents trying to bestow assets to their children.

While many of these options can involve a complex legal framework, a simplified answer for parents can be custodial accounts covered under the Uniform Transfers to Minors Act (UTMA).

The main problem is children are not responsible or knowledgeable enough to possess assets at such a young age, which makes them prone to mismanagement. Additionally, children under the age of 18 do not posses the ability to contract, therefore deterring third parties from doing business with them. Custodial accounts set up under the UTMA provide simple remedies to these problems.

What are UTMA Accounts?

UTMA accounts are typically set up by adults on behalf of a minor through a financial institution such as a brokerage firm or a bank. The account can hold both tangible and nontangible assets, as well as real or personal assets. The assets are held and maintained by a designated custodian until the child reaches the age of majority, or the age determined by statute.[2] It is important to note that while most states accept some form of the UTMA, statutory differences are possible between states.

The UTMA expanded upon the preexisting Uniform Gifts to Minors Act, and today 48 states and the District of Columbia have their own form of the UTMA in place. Two states, Vermont and South Carolina, still operate under a form of the Uniform Gifts to Minors Act.[1] In Nevada, the custodian maintains the assets in a UTMA account until the minor reaches the age of 18 absent a stipulation made at the time of the transfer. Under Nevada statute, gifts can be withheld until the age of 21, and transfers of exercise of power can be withheld until 25.[3]

With UTMA accounts, the custodian can be a parent, a donor, or a third party. The custodian holds no legal rights to ownership as all of the assets in the account belong to the minor, but they are able to disperse, invest, and manage the assets for the benefit of the child. While this statement may seem broad, it excludes parental obligations such as child support from being taken from the minor’s UTMA account. However, generally acceptable uses of funds are to pay private school tuition, or send a child to summer camp. Under Nevada statute the custodian is able to deal with custodial property with “a standard of care that would be observed by a prudent person dealing with the property of another, and is not limited by any other statute restricting investments by fiduciaries.”

Limitations of UTMAs

It’s important to note that once a transfer from a UTMA is made, the gift becomes the absolute property of the minor and cannot be taken back. Once the minor reaches the age of majority, or other age as specified, they gain the ability to do whatever they wish with the assets in the account, regardless of the wishes of the donor or custodian. Once it’s given as a donation, even if the intent was not permanent, it is very difficult for the donor to reclaim the gift. While this holds true for most circumstances, if the gift was not the sole property of the donor, the other owning party may seek to reclaim the asset if they did not consent to the transfer.

Using UTMA Accounts to Pay for College

Parents will often set up a UTMA account for their minor child to go to college, but again this approach has its limitations. The irrevocable gifts made to UTMA accounts makes the assets the outright property of the minor once they reach the age of majority. As a result, they choose what they want to do with the funds in the account.

For example, parents set up a UTMA account for their 2 year old child with the idea of putting the money away for college. The parents regularly make deposits into the account, and by the time the child reaches 18 years old, there is enough money in it to pay for all of their college expenses. This seems like the best case scenario for the parents, but what if the child decides that they don’t want to go to college? Instead, the child takes the money from the account and buys a new car. To make matters worse, any attempt by the parents to reclaim those funds would be considered illegal.

If a child does not want to use the funds in their UTMA account to pay for college they do not have to, regardless of the intentions of the donor or custodian. In many cases, the child would probably be grateful for the funds provided to them for their education, but the risk that the funds will be used incorrectly still exists for donors. Additionally, since the minor child owns the assets in a UTMA account, they will be considered as the income of the child in the financial aid process.[5] This can greatly impact how much financial aid the child receives when applying to schools.

Tax Benefits of UTMA Accounts

There are tax benefits for UTMA Accounts, but they have limitations. UTMA accounts are exempt from the “trust tax,” and since Nevada does not have a state income tax only federal tax law applies to UTMA accounts in Nevada. The first $950 of unearned income for the minor is exempt from federal income tax, the second $950 of unearned income is taxed at the child’s tax rate (likely to be lower than the donor), but anything over $1,900 is taxed at the parent’s rate.[4] For smaller gifts to a minor a UTMA account can be an effective way to see investments for a child grow without much of a tax burden, but larger gifts will still be taxed as though they belonged to the parent.

Other Options for Funding a College Education

When planning for college there are other options available other than UTMA accounts. Section 529 of the Internal Revenue Code allows for qualified tuition programs. An account set up under Section 529 is tax exempt, and not considered the property of the minor for financial aid purposes.[6] To take advantage of a 529 account, the funds in it must be earmarked for higher education expenses, and withdrawal of funds for other purposes will result in stiff penalties. If providing funds specifically for a college education is the goal, a qualified tuition program could be a better option than a UTMA. The design of the account ensures that the funds will be used for college expenses, and it offers tax incentives that UTMA accounts cannot provide.

If providing for college expenses is not a priority, and large sums of money are being transferred to a minor a traditional trust might be a better option. Trusts are more complicated, place the trustee at a greater liability, and are subject to taxation, but they allow for a higher level of control over the funds within them. If the goal were to prevent the minor child from becoming an 18 or 21-year-old millionaire, then a traditional trust would be a better option than a UTMA account. Traditional trusts are not subject to the same age limitations that UTMA accounts are, and the way in which the contents of the trust are to be dispersed to beneficiary can be laid out in the trust.[7]

In conclusion, custodial accounts set up under the Uniform Transfers to Minors Act can be an effective tool for small gifts to a minor to help plan for their financial future. While UTMA accounts offer a simple and inexpensive way to transfer assets to minors they are not without their limitations. There are a variety of different options available when planning for a child’s financial future, and knowing which one fits the needs of the child and meets the wishes of the donor will make financial planning much easier.

Scott Cooper is a political studies major at Colby-Sawyer College in New London, New Hampshire. He wrote this article while a legal intern at Sutton Law Center.

[1]http://www.uniformlaws.org/ActSummary.aspx?title=Transfers%20to%20Minors%20Act

[2] Wilder, Joanne. 2006. “Spending the Children’s Money: A Critical Look at Custodial Accounts.” American Academy of Matrimonial Lawyers 20 (127).

[3] NRS 167.034

[4] Franklin Templeton Investments. “UGMA/UTMA Accounts”. https://www.franklintempleton.com/investor/products/goals/education/ugma-utma-accounts?role=investor#financial-aid-implications

[5] Wilder, Joanne. 2006. “Spending the Children’s Money: A Critical Look at Custodial Accounts.” American Academy of Matrimonial Lawyers 20 (127).

[6] 26 USC 529

[7] NRS 163

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