A Uniform Transfer to Minors Account, or UTMA account, is a way to open an investment account for a child. Since minors can't legally own assets, a UTMA holds assets on a custodial basis for a child until age 18. Using funds improperly can trigger various penalties, some quite severe. Uniform Transfer to Minors Accounts carry certain tax advantages, but their structure also can be limiting.
How UTMAs Work
Money placed into a UTMA accrues immediately to the benefit of a child. While a custodian is placed in charge of the account, the money technically belongs solely to the child. Gifts to the account are irrevocable and cannot be taken back. The money in the account only can be used for the child's benefit, such as for school expenses or other educational purposes. Once the minor turns age 18, he has legal control over the assets, which then can be used for any purpose.
There are no limits as to who can contribute to a UTMA, nor are there any contribution limits. However, donors may be liable for the gift tax if they contribute more than the annual gift tax exclusion amount, which was $14,000 as of 2015. Anyone legally can be the custodian of a UTMA, although typically a parent is chosen. While the custodian cannot use the assets in the account, she is free to choose the investments in the account.
Income generated within a UTMA is taxed using a tiered structure. The first $1,000 generated within a UTMA is tax-free, while the next $1,000 is taxed at the child's rate. Amounts above $2,000 are taxed at the parents' rate. This tax structure is to prevent parents from transferring assets into a UTMA solely to benefit from a child's lower tax rate.
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Once you've established a UTMA for a beneficiary, you cannot change who will receive the money. After the beneficiary turns 18, he can use the money for whatever he likes, even if you had intended the money to be used strictly for educational purposes. Along the way, earnings in the account are taxable every year. Perhaps most importantly, assets in a UTMA are regarded as belonging to the child on financial aid applications, which can hurt aid eligibility.
If you change your mind and want to take money out of a UTMA for your own purposes, you might run afoul of the law. Cleaning out an account to avoid financial aid problems could trigger federal criminal charges, as that is considered fraud. Using the account as a tax shelter for your own investments also could cause problems with the IRS.