Can An UTMA Be Used To Buy My Kid a Car?
A couple of months ago my son, age 11, told me he wanted to invest in stocks.
In case you haven’t noticed by the website and YouTube channel, I’m a bit of a finance enthusiast, so I was intrigued.
“Why do you want to invest in stocks?”, I asked.
“So, I can buy a car.” He replied. (He meant in a few years.)
I thought this was a splendid idea.
Granted, buying stocks on a five-year horizon isn’t exactly the safest way to go, but it’s not as if we’re talking about a lot of money and I really love the idea of him having a vested interest in investing.
If he experiences a loss in value, it will be a good lesson, but his mother and I can still step in to help make him whole.
Besides, his little sister hates getting left out and this situation is no different. She wants to invest also and is 2.5 years younger than her older brother.
A Kiddy Account?
But where do you invest money for a kid? They can’t open their own brokerage accounts until they’re 18.
As it happens, some of my son’s friend’s parents had set up accounts with an app called “Greenlight”.
This is not a review of the Greenlight app. After looking into it, I was a little disappointed to see that it is a subscription-based service.
Compared to the amount of money my kids want to invest, the minimum fees at Greenlight would equate to about 12% of the account’s total value per annum.
This is not a very good value.
Don’t get me wrong. There are a lot of neat features that are offered in the app and I think for the right family it could be a great tool. It’s just not for us.
Undeterred, I began to investigate other options.
We have invested primarily with Vanguard for over 15 years now. They are renowned for having very low-cost mutual funds and ETFs and they haven’t given me a reason to leave, so that’s where the bulk of our investment assets reside.
Imagine my disappointment when I discovered that Fidelity has youth accounts, but Vanguard does not.
Fidelity has a free, feature-rich account for teens that has all the features I’d like for my kids’ own money one day.
However, my children don’t yet have phones to manage an app and they don’t need debit cards, so this isn’t a deal breaker at the moment.
In a couple of years, if Vanguard hasn’t stepped up their game, we might move everything over to Fidelity. Vanguard just seems to be a step behind them these days.
Well, back to the options at Vanguard.
One thing we considered was just setting up another brokerage account in our own names and using them as investing accounts for the kids.
The only problem with the plan is the money is still legally ours and all dividends and capital gains would have been taxed at mom and dad’s income, dividend, or income tax rates.
As it happens, I knew of another account type that would ensure most, if not all, of the kid’s dividends and gains could be completely tax-free.
UTMA to the Rescue!
The Uniform Transfers to Minors Act (UTMA) and its close relative, the Uniform Gifts to Minors Act (UGMA), allow parents to transfer or give assets to children while they are still minors and in very, very low tax brackets.
A custodian is appointed (almost always the person who establishes the account) and oversees the assets on behalf of the minor until they reach the age of majority in their state.
Gifts to an UTMA or UGMA receive the annual IRS Gift Tax Exclusion ($18,000 per person in 2024) and can be made as cash, stock, real estate, property, art, etc.
The assets in the account can be invested and the first $1,300 (as of 2024) of capital gains or dividends each year are tax-free.
The next $1,300 is taxed at the minor’s tax rate which is presumably lower than that of the account’s benefactor.
Once earnings in the account exceed $2,600 in a year, they are taxed at the parent’s rates for income, capital gains, and/or dividends.
For example, let’s assume a couple is in the 24% tax bracket and owns a handful of stocks that earn $1,000 in capital gains and $500 in non-qualified dividend income in 2024.
The parents will owe $150 for the long-term capital gains (taxed at 15%) and $120 for the dividends (taxed at their marginal income tax rate), for a total tax liability of $270.
However, if they elected to gift these stocks to one of their children through an UTMA, the child would only be taxed on $200 because this is the amount that exceeds their standard deduction of $1,300*.
Since the minor child’s marginal tax rate is 12%, they’ll owe $24 in taxes for a total tax savings of $246.
(*We’re also assuming the minor in this case does not have any earned income.)
A Couple of Things to Keep In Mind
The transfer of assets into an UTMA or UGMA is irrevocable, so be sure you’re ready for said assets to become the property of the minor beforehand.
Also, assets in an UTMA or UGMA belong to the minor and will work against them if they apply for financial assistance as they approach college age.
And before you decide to use an UTMA or UGMA to fund education, I’d encourage you to take a hard look at a 529 savings plan first.
529s can come with state income tax breaks, they provide tax benefits while also remaining the property of the account owners (meaning it won’t impact financial aid for the beneficiary quite as much), and there are no limits on the amount of earnings you can shelter from taxes in a 529.
To be honest, comparing an UTMA to a 529 as a college savings vehicle is not a fair comparison.
It would be a bit like concluding Michael Jordan wasn’t much of an athlete because he couldn’t have beaten Usain Bolt in a 100-meter sprint.
They’re both incredibly skilled athletes in their respective sports, but their fitness was refined for very different purposes.
If you know you’ll be using the money for education, the 529 is the easy choice, but that doesn’t mean an UTMA doesn’t have a strategic place in your overall financial plan.
Finally, you should know that the assets in an UTMA/UGMA can be removed before the minor’s age of majority as long as they are used for the benefit of the minor.
Conclusion
In the end, we elected to open an UTMA for each child and look forward to seeing these accounts earn money while our kids learn about investing and avoiding taxes at the higher tax rates of their parents.
The accounts are a snap to set up if you already have a brokerage account with a custodian. You just need your kid’s social security number and a few minutes in front of a computer.
It will take a bit longer to fund the account if it is the first one you have with your institution of choice.
