Uniform Gift to Minors Act

A Custodial Account College Savings Program

Nov 22, 2009 Jennifer Ciotta

Parents saving for college can start a special trust for their child's future education. Learn about opening one for a minor and the kiddie tax downside of this trust.

In the past, to start a trust for a child, a parent or grandparent had to go through lawyers and sign a battalion of papers. It was not an easy process to begin. In addition, a trust is usually a luxury bestowed upon the very rich in modern society. However, with the advent of the Uniform Gift to Minors Act (UGMA), opening a trust in a child's name is possible for those at any type of stable income level.

Typically, a child is not allowed to have securities (stocks, bonds, mutual funds, etc.). This is a law in many states. Additionally, parents cannot pass their securities onto their children, instead only having the option of doing so through setting up a trust for when the child turns eighteen or older. With the introduction of the UGMA in certain states, this changed the way to save for college.

UGMA College Savings Options

Parents, or many times grandparents, start an education fund for higher learning at the child's birth. With the soaring price of both public and private universities, this is a good way to ensure that eighteen years down the road, the child can afford college. Even now, in a time of economic recession, experts recommend putting in as little as $50 a month into an educational savings plan.

With the UGMA, a parent (or grandparent), also known as the donor or custodian, must designate a beneficiary (the child) to begin an account. It is set up in the child's name, and the age of termination must be determined by the donor. For example, the trust can terminate when the child turns 18, right in time for her/his freshman year of university, or up until the age of 21, if the donor thinks a few more years is a safer option. Here are some tips on starting an account:

The child must have a valid social security number, thus s/he must be a US citizen or permanent resident.
The donor must decide on the age of termination. It depends on the state, so ask a financial adviser or check with state guidelines. Most trusts end at 18 years of age.
A UGMA account is set up at a bank or brokerage house.
The donor must be economically secure and ready to donate to the trust and manage its assets.

UGMA Tax Rules: Is This Account the Best Way to Save for College?

When these accounts began, they were taxed as part of the custodian's estate. Yet the investments were declared in the child's name, not the parents', thus the parents were taxed at a very low rate. This proved to be an excellent lowering tax strategy for many wealthy families.

However, times have changed. According to Forbes, UGMA accounts, "produced substantial tax savings for many families. So substantial, in fact, that Congress took notice and decided to do something about it. The result was a set of rules under which children below age 14 with more than a nominal amount of investment income would pay tax at their parents' tax rate. Thus, was born the 'kiddie tax.'"

Another drawback to the UGMA account is that colleges use it to evaluate investments, thus the child will have a much lesser chance of receiving the best financial aid package possible. After years of scrimping and saving, this is a let down for many parents.

Compare a UTMA and 529 Plan

Here are three articles that discuss the pros and cons of other account options:

This article, Uniform Transfer to Minors Act, discusses how to open the account and the positives and negatives of it.
This article, UGMA vs UTMA Account, compares and contrasts both types of trusts.
This article, 529 College Savings Plans, discusses the potential benefits and drawbacks of this popular education savings plan.

Parents can be responsible right from birth and start the education savings account that is best for them and their children. A UGMA account has the benefits of a trust, but drawbacks that may cause a parent to think twice about opening one. The best way to find the right plan for a child is to do research and ask a lot of questions.

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