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Parents want their children to thrive in their lifetime. When it comes to wealth, they understand how hard the world can be as they continue to support them. Now, they want to leave wealth in a way that supports them financially. As a result, they are more intentional about the wealth they want to leave.
The traditional go-to for creating wealth has been custodial accounts, commonly known as UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfers to Minors Act). At first glance, they seem like a solid idea with good intentions:
But dig a little deeper, and you’ll uncover some significant drawbacks—ones that could impact your child’s future or limit your control. So, what’s the issue, and are there alternatives? Let’s break it down.
While UGMA/UTMA accounts provide a straightforward way to save for a child’s future by leaving them funds in a way they can learn, their restrictive nature creates challenges for many families. Here’s what you need to know:
So, while these accounts can serve as a tool to teach kids about money management, their limitations often could outweigh their benefits. Fortunately, there are other ways to save for your child’s future while keeping more flexibility and control in your hands. If UGMA/UTMA accounts do not align with your family’s goals, here are three options that can provide more advantages.
The first option would be the 529 plan, which is the the go-to option for parents who want to save specifically for education expenses. Here’s why it is:
Plus, starting in 2024, unused 529 funds can be rolled into a Roth IRA, though there are strict rules and limitations on how this can be done. This adds a layer of flexibility for families worried about overfunding the account. It is also worth noting you can transfer funds from a UTMA / UGMA to a 529. However, this does require selling the funds, realizing any of those capital gains, and the funds must be for the original beneficiary.
But like most tax-advantaged accounts, there are restrictions to consider. If the funds are not used for education, the earnings would be subject to income taxes and a hit 10% penalty. So, make sure these are used for education purposes.
Yes, this has "custodial" in it's name. However, it does come with perks worth noting
However, while the asset itself does not count against FAFSA, the income needed to contribute towards it does. To contribute to an IRA, there must be "earned income," and for the custodial, the earned income must come from the child, not the parent. The contributions are limited by the earned income up to $7,000 for 2024. Generally, they will examine income for the last years before applying, so it's important to plan around that when it comes.
In addition, the distribution of funds must not be used for education purposes, or it will be counted as a child's asset for FAFSA. Similar to the 529, intent matters. If you desire to leave wealth for them and build their retirement nest egg, this is worth considering with tax-free benefits.
For parents who want full control over their savings and flexibility in how funds are used, a taxable brokerage account is one to consider. Here's why:
If you plan to use these funds for your child, you could "gift" them up to the exclusion amount with the investments or the proceeds after selling them off. So, if you're looking to accomplish goals like a purchase for them, not necessarily for education purposes, a taxable brokerage account under the parent's name can provide that flexibility.
The Bottom Line
Accounts like the UTMA and UGMA are not bad by any means. They can serve a great purpose in building wealth for your kids. However, depending on your goals, alternatives like 529 plans, Custodial Roth IRAs, and taxable brokerage accounts can offer flexibility, tax benefits, and control over how and when the funds are used.
Don't just pick the account because the crowd says so. Choose the option that makes sense for YOU.
You know how to make money, but you're not sure if you're making the right moves financially. That's why I started Pashman Financial.
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PASHMAN FINANCIAL, LLC (“Pashman Financial”) is a registered investment advisor offering advisory services in California and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by Pashman Financial in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. All written content on this site is for information purposes only. Opinions expressed herein are solely those of Pashman Financial, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.
