Financial Experience for Minors: When to Consider an UTMA Account
By Chelsea Adams, PhD
If you’re involved in a child’s life, whether your own child, part of the extended family, or an honorary member of the family, you want them to have all the tools they need to succeed in life early on so they can thrive as they get older. Learning about finances is an important part of that equation, but it can be hard to know what options are best for teaching kids how to handle money and build wealth. While many people think about opening their child a bank account and teaching them to put away money for a rainy day—an important part of basic finances—they often forget about teaching investment skills to their children. One potential way to help children learn about the stock market is to open a custodial account for them through the Universal Transfer to Minors Act.
How do I Open an Account?
Any adult can open an account for a minor: they don’t have to be related to them. The account is opened in the minor’s name, and the adult can name a custodian, also known as the person in charge of managing decisions in the account. The custodian can be the person who opens the account, or they can appoint another responsible adult. The person who opens the account then chooses how much money they want to put in the account for the child. It’s important to know that the money, once put in the account, is the child’s, and cannot be taken back or revoked in any way by the person who gifted the money. The contribution is considered an irrevocable gift, and the child is known as the beneficiary of it.
As the child gets old enough, the custodian can have meetings with them to discuss the investment choices in their account and help them learn how to make decisions about what is best to invest in for them. It’s also wise to let them meet with the financial advisor helping with the account so the child can learn how to have important conversations with their financial professional early on. The advisor, custodian, and minor can counsel together to make decisions on account changes and investment additions.
How Much Can I Contribute and What can That Money be Used for?
Unlike college savings accounts, which have contribution limits and can only be used to cover college expenses, UTMA accounts have no contribution limit and funds can be used for anything that would benefit the minor. Potential expenses can include, but are not limited to
- Private school tuition
- Computer for school
- Specialty programs
If parents are worried about a child’s future health and medical expenses, it may also help children have funds to draw from if they are no longer on the parents’ insurance and need a financial boost. However, it is important to remember that custodians may not withdraw money for regular, routine childcare expenses such as groceries, rent, or other household expenses.
What about Taxes?
Custodial accounts belong to the minor, so the IRS taxes the child tax rate. For 2022, the first $1,150 of unearned income (i.e. growth and income from investments) is tax free. The next $1,150 is taxed at 10%, known as the “kiddie tax.” Any unearned income above the first $2,300 is taxed at the parents’ tax rate. If the beneficiary goes to school full time between the ages of 19 and 24, the same tax rate applies unless they are paying for more than half their own expenses from earned income.
This can be a good opportunity to teach children about taxes, tax brackets, and the importance of keeping track of earning and spending. Talk with your financial advisor about how to approach the subject, or talk to your accountant about meeting with the child to go over the basics of their taxes.
When does the Child Control the Account?
At the age of majority, the child will gain full control over the account, and the custodian will relinquish the ability to make investment decisions for the account. Furthermore, donors and custodians cannot set conditions on how the beneficiary uses the funds. When they gain full control of the account, they can use the money for anything they see fit, or continue investing it.
Age of majority varies from state to state, usually ranging between ages 18 and 21, but can be extended up to age 25. It is important to check with your financial advisor to know what the age of majority is where you live so you can prepare for the transfer in a timely manner.
In summary, an UTMA account can be a good option to put aside money to invest for a child and to help them with future expenses they may incur. It can be a great opportunity to teach children about how investments work and how to make good investment decisions. However, unlike college savings plans, the money cannot be earmarked for a specific purpose, and the money is considered an irrevocable gift. The account will also be taxed, and may require the child to file a tax return. It is important to weigh your investment account options with a financial professional before determining which account would be best for you and the child beneficiary.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Stratos Wealth Partners, Ltd., a registered investment advisor and a separate entity from LPL Financial.
The Opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
LPL Financial does not provide tax advice. Clients should consult with their personal tax advisors regarding the tax consequences of investing.