A custodial account provides a way for a donor (usually parents or grandparents) to gift cash and/or assets to a minor via a simple and cost effective account. The Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) account enables the custodian to provide management of the account and to direct distributions for the benefit of the child until the child reaches the age in which they can control the account, usually age 18 or 21. For estate tax purposes, if the donor and the custodian is the same person and if they predecease the beneficiary before the age of majority, the gift amount will not be considered a completed gift. Specific terms of UGMA and UTMA accounts are determined by state statute.
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 education purposes. Since UGMA and UTMA accounts are in the name of a single child, the funds are not transferable to another beneficiary.
The income from the custodial account must be reported on the child’s tax return and is taxed at the child’s rate. There is no special tax treatment for UGMA/UTMA accounts.
Uniform Transfer to Minors Act (UTMA) is the most common custodial account and allows for a minor to own securities and other types of property, such as real estate, fine art, patents and royalties, and for the transfers to occur through inheritance. The Uniform Gift to Minors Act (UMGA) allows for a minor to own securities. UTMAs are slightly more flexible than UGMAs. For college financial aid purposes, custodial accounts are considered assets of the student. This means there is a high impact on financial aid eligibility.
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