Many individuals create custodial accounts for their minor children under the Uniform Transfers to Minors Act (UTMA) because these accounts are so easy and relatively inexpensive to establish and maintain.8
The accounts are attractive also because assets in an UTMA account may be invested in any manner the custodian chooses.
Moreover, while the beneficiary is a minor, the custodian can use the funds for any purpose—so long as it is exclusively for the benefit of the minor beneficiary.
However, when the beneficiary reaches age 21, the custodian ceases to control the account and the beneficiary may spend the funds directly in any way he or she chooses (so long as it's appropriate for the minor).
And therein lies a potential problem:
Assume two parents contribute their aggregate gift tax annual exclusion amount (a total of $30,000 every year) to a child’s UTMA account, starting when the child is an infant. If the parents do not carefully supervise the value of the account, their child—at age 21— could gain control over an account valued at over half a million dollars (not counting 21 years’ worth of appreciation). And of course, by then, it would be too late to question the advisability of giving so much to someone so young.
Other disadvantages of UTMA/UGMA accounts include:
- Restricted Assets - Contributions must be made in cash.
- Income Taxes - Contributions must be made with post-tax dollars. Earnings in the account are subject to current income and capital gains taxes, typically subject to the beneficiary’s parents’ tax rate.
- Gift Taxes - Contributions are considered taxable gifts, which is why funders often limit their contributions to the annual exclusion amount.
- Estate Taxes - If a beneficiary’s parent is both the custodian and a donor, the value of the UTMA account would be included in that parent’s taxable estate for estate tax purposes if he or she dies while the account is still in existence.