More on How to Use UGMA or UTMA Custodial Accounts for College

UGMA or UTMA Custodial Accounts for CollegeUGMA and UTMA?  Wait! There’s more. Just like the amazing Ginsu knives on late night TV we’re back with more about college money options. In this second part of my post I’ll focus more on how to use UGMA or UTMA custodial accounts for college and the impact of taxes and financial aid eligibility.  For a primer or a review, please see Part I in this two-part blog.

Investment Options and Tax Benefits for Custodial Accounts

Investment Options:
Custodial accounts allow typical stock, bond, and mutual fund investments. Due to their custodial and protective nature, they are not permitted ownership of higher risk investments like stock options or buying on margin.  And that’s not a bad thing for all you armchair stock jockeys out there.

Tax Benefits:
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. The reality is, custodial accounts don’t actually grant this privilege, but simply take advantage of it.

Every child under 19 years old (or 24 if a full-time student), who files as part of their parents’ tax return, is allowed a certain amount of “unearned income” at a reduced tax rate. Currently, the first $1,000 is considered tax-free, and the next $1,000 is taxed at the child’s bracket (10% for Federal income tax).

Anything above those amounts is taxed at the parents’ rate, which may be as high as 35%.

This exemption is per child, not per account. Thus, if the child already has a high level of unearned income (e.g., investment income), opening a custodial may not make a difference.

Eligible Expenses and Effect on Financial Aid for Custodial Accounts

Eligible Expenses:
Any expense that is for the benefit of the child may be paid from the custodial account, at the custodian’s (usually the parent) discretion.

Effect on Federal Financial Aid Eligibility:
Custodial accounts are considered an asset of the child they are set up for, and therefore are counted heavily against financial aid. Approximately 20% of these assets will be expected to be used towards funding a student’s education in any given year.

Note: One way to mitigate this is to transfer assets remaining in the UTMA/UGMA into a 529 Savings Plan account.

Contribution and Eligibility Rules for Custodial Accounts

Any adult can set up a custodial account for any child under age 18.

Contribution Rules:
There are no contribution limits. However, someone setting aside money in one of these accounts needs to be aware of how larger gifts affect their annual gift tax and lifetime estate tax exclusions.

Contribution Deadline:
There is no contribution deadline for custodial accounts.
Withdrawal Rules and Treatment of Unused Funds for Custodial Accounts

Withdrawal Rules:
A withdrawal can be initiated by the custodian for the benefit of the child, as long as the expenses are for legitimate needs. Withdrawals are not limited to college costs, and can be used for pre-college educational expenses.

Treatment of Unused Funds:
Any unused money must be distributed to the child by the time they reach the age of majority or the maximum age allowed for custodial accounts in their state. For classic UGMA accounts, this is generally age 18. For the newer UTMA accounts, this is usually age 21, but may be as late as age 25.

Unlike Section 529 plans and Coverdell ESA’s, there’s no ability to transfer the account to another child or change beneficiaries.


Before you set up a custodial account consider whether keeping your assets in your own name is more appropriate for your situation. Retaining control of your money may turn out to be a smart move if you end up needing the money for your own uses – say for a house or for an emergency if you run into hard times.

Custodial accounts are best suited for small amounts and make the most sense when you (or a relative) genuinely want to make a financial gift to a child. If you’re giving significant sums to your child or your family has special needs, trusts provide greater control and flexibility. In this case setting up a living trust for the benefit of the minor child with guaranteed distribution ages very high or in stages (for example, in one-third at age 25, etc.) while at the same time leaving the parent or trustee with the power to make discretionary distributions for the care and maintenance of the child (referred to as a HEMS clause).

An ideal hybrid strategy would be to fund a UGMA / UTMA and draft a living trust. This way you have the flexibility to fund needs not limited to college through the early years and can then use the trust to hold the bulk of assets which can be controlled more directly by parents or custodians for a longer period.

If you’re saving for your child’s college education, tax-advantaged alternatives to consider include an education savings account (ESA) or a 529 college savings program though ESAs limit contributions to $2,000 annually and 529 Plans have potentially higher management expenses with a more limited set of investment options.

Parents who are interested in getting the most from both UTMA / UGMA accounts and the more tax-favored 529 plans can transfer remaining assets from the UTMA / UGMA to a specially designated UTMA / UGMA 529 Plan. In this case, the withdrawals from the 529 account become tax-free (under current rules) when used for qualified education expenses and the account balances are treated more favorably for financial aid calculations as they are considered parental assets assessed at 5.64% versus the 20% student rate applied to UGMA / UTMA account assets.