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UGMA & UTMA Custodial Accounts


In most states, minors do not have the right to contract, and so cannot own stocks, bonds, mutual funds, annuities and life insurance policies. In particular, parents cannot simply transfer assets to their minor children, but instead must transfer the assets to a trust. The most common trust for a minor is known as a custodial account (an UGMA or UTMA account).

The Uniform Gift to Minors Act (UMGA) established a simple way for a minor to own securities without requiring the services of an attorney to prepare trust documents or the court appointment of a trustee. The terms of this trust are established by a state statute instead of a trust document. The Uniform Transfer to Minors Act (UTMA) is similar, but also allows minors to own other types of property, such as real estate, fine art, patents and royalties, and for the transfers to occur through inheritance. UTMA is slightly more flexible than UGMA.

To establish a custodial account, the donor must appoint a custodian (trustee) and provide the name and social security number of the minor. The donor irrevocably gifts the money to the trust. The money then belongs to the minor but is controlled by the custodian until the minor reaches the age of trust termination. (The age of trust termination is 18 to 21, depending on the state and whether it is an UGMA or an UTMA. Most UGMAs end at 18 and most UTMAs at 21, but it does depend on the state.) The custodian has the fiduciary responsibility to manage the money in a prudent fashion for the benefit of the minor. Custodial accounts are most often established at banks and brokerages.

Any money in custodial accounts for which you are the custodian will be counted as part of your taxable estate if you are the legal guardian of the child and the child has not yet reached the age of trust termination.

It is important to title the account correctly. An "In Trust For" account, also known as a Totten Trust or guardian account, is not an UGMA/UTMA account. It is a revocable transfer that passes to the beneficiary without probate upon the death of the donor. (Totten Trusts are assets of the account owner, not the beneficiary, for financial aid purposes.) The proper way of titling a custodial account is "[Custodian's Name] as custodian for [Minor's Name] under the [Name of Minor's State of Residence] Uniform Gift to Minors Act". Substitute the word "Transfer" for the word "Gift" if you intend to establish an UTMA account instead of an UGMA account. Note that this method of titling is only correct for the US. In Canada, for example, one would title the account "[Custodian's Name] as trustee for [Minor's Name], a minor".

Account Title Account Type Whose Asset on FAFSA
Parent in trust for Child Totten Trust Parent
Child in trust for Parent Totten Trust Child
Parent and Child Joint Account Split Evenly
Child and Parent Joint Account Split Evenly
Parent as custodian for Child Custodial Account Child
Parent as trustee for Child Custodial Account Child

The income from a custodial account must be reported on the child's tax return and is taxed at the child's rate, subject to the Kiddie Tax rules. The parent is responsible for filing an income tax return on behalf of the child. There is no special tax treatment for UGMA accounts. Children aged 14 and older must sign their own tax returns.

Neither the donor nor the custodian can place any restrictions on the use of the money when the minor becomes an adult. At that time the child can use the money for any purpose whatsoever without requiring permission of the custodian, so there's no guarantee that the child will use the money for his or her education. Also, since UGMA and UTMA accounts are in the name of a single child, the funds are not transferrable to another beneficiary.

Impact on Student Aid Eligibility

For financial aid purposes, custodial accounts are considered assets of the student. This means that custodial bank and brokerage accounts have a high impact on financial aid eligibility.

However, since 2009-10 the treatment of custodial 529 college savings plans has been more favorable. A custodial 529 plan of a dependent student is treated as an asset of the parent on the Free Application for Federal Student Aid (FAFSA). (A custodial 529 plan of an independent student is still treated as a student asset. Also, the CSS/Financial Aid PROFILE form treats 529 plans that name a student as a beneficiary as an asset of the student regardless of who owns the 529 plan account.) This means that a custodial 529 college savings plan for a dependent student has a low impact on financial aid eligibility.

Thus one method of dealing with the financial aid impact of an custodial bank or brokerage account is to liquidate the account and transfer the proceeds into a custodial 529 plan account. (Investments in a 529 plan must be made in cash.)

If money is transferred from an UGMA/UTMA account to a section 529 plan, the section 529 plan should be titled the same as the UGMA/UTMA account. When the child reaches the age of trust termination, the child will become the account owner for the section 529 plan. The custodian is not permitted to change the beneficiary of the section 529 plan, because the responsibility of the custodian to use the assets of the UGMA/UTMA account for the benefit of the child does not terminate when the funds are withdrawn from the account.

(Prior to 2006-07, funds in a custodial 529 college savings plan were treated as a child asset on the FAFSA because they derived from an irrevocable gift to the child. Congress attempted in the Higher Education Reconciliation Act of 2005 to change the treatment from a child asset to a parent asset. However, a legislative drafting error causes custodial 529 plan accounts to not be reported as an asset on the FAFSA. Congress corrected this error in the College Cost Reduction and Access Act of 2007, but with a year delay in the effective date to July 1, 2009, the 2009-10 award year. The correction treats qualified education benefits as an asset of the student if the student is an independent student and an asset of the parent if the student is a dependent student, regardless of whether the student or parent owns the account.)

Undoing a Transfer/Gift

It is not possible to transfer money back to the parent from a child's custodial account because the original transfer was an irrevocable gift. Once the money has been given to the child, it is owned by the child. The child does not have the capacity to gift the money back to the parent, and the custodian would be violating his or her fiduciary responsibility if he or she transferred the money back into his or her own name or used it for his or her own personal benefit. (If a custodian does this, or otherwise behaves in a fashion that the IRS interprets as indicating that no gift was actually ever made, the custodian would owe back taxes at his or her rate, plus penalties. Also, the child could sue to recover the funds.)

However, nothing prevents the custodian from spending the money for the benefit of the child, so long as the expenses aren't "parental obligations" or otherwise benefit the custodian. Parental obgligations are expenses a parent is normally expected to provide for his or her child, such as food, clothing, medical care and shelter. But if your child wants a computer or to go to summer camp, it is usually acceptable to spend the child's money on those expenses. Likewise, you can spend the child's money for the child's college education. The parent can then set aside some of his or her own money in a college savings account owned by the parent. Obviously, this only works if there are non-parental obligation expenses that the parent would otherwise have provided for his or her children. Attempts to undo an UGMA transfer in this fashion should only be done in consultation with a qualified accountant.

(The model UTMA legislation included a paragraph that would permit the money in a custodial account to be spent for the use and benefit of the minor "without regard to (i) the duty or ability of the custodian personally or of any other person to support the minor, or (ii) any other income or property of the minor which may be applicable or available for that purpose". Although one might argue that this would allow one to spend the money even on parental obligations, it is important to note that this paragraph was not generally included in state UTMA legislation, nor UGMA legislation. Often, when this language was included, an additional clause stating "A delivery, payment, or expenditure under this section is in addition to, not in substitution for, and shall not affect any obligation of a person to support the minor." was added as well as a requirement to "keep custodial property separate and distinct from all other property". In addition, there are tricky tax consequences to spending the money on parental obligations. It is clear that if you spend the money for the benefit of the child on nonparental obligations, you're ok. Anything else, check first with an accountant who is familiar with the laws of your state.)

The Deficit Reduction Act of 2005 added another method of eliminating the negative financial aid impact of a custodial account. Effective July 1, 2006, the custodial versions of 529 college savings plans, prepaid tuition plans, and Coverdell Education Savings Accounts are treated as the asset of the parent for federal student aid purposes when the student is a dependent student. So if you roll over a custodial account into one of these three types of accounts you will shift its financial aid treatment from a student asset to a parent asset.


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