Two ways to give a tax-free gift
A small investment can grow into a substantial tax-free gift
Wealth education includes knowing how to give a tax-free gift of money or assets. The Uniform Gifts to Minors Act, also referred to as the UGMA, was created in order to make it easier to gift tax-free assets and money to children. Parents, grandparents and others can open a UGMA account or a similar UTMA account, which stands for the Uniform Transfers to Minors Act, in a child’s name. The account can then be used to give financial gifts, as well as to purchase investments, such as stocks and bonds for the child. The adult who opens the account is the account’s custodian until the child reaches the legal age required to manage their own account, and accounts are always governed by the laws of the particular state where they were established.
Tax-free UGMA and UTMA investments
With either a UGMA or a UTMA investment, yearly taxes are not due until the gains on the account total a minimum of $1,700 dollars. When taxes are due, however, they are based upon the child’s parent’s highest marginal tax rate until the child turns 18 and then the taxes are calculated according to the child’s lower tax rate. In fact, the initial unearned income totaling $850 is tax exempt for the child regardless of age. The second $850 in unearned income is taxed based upon the child’s current tax bracket. When the unearned income from the account grows beyond $1700, the child’s age is used to determine whether taxes will be based upon the parent’s tax bracket or the child’s.
The difference between UGMA and UTMA tax-free gifts
The difference between these two accounts are that the UTMA may allow an adult to retain control of the account for a longer period of time, such as until a child actually completes college. Also, UTMA accounts may allow the adult custodian to put off the account’s final distribution of funds until the child reaches twenty-five years old. While this is not true in the case of every UTMA account, since rules vary according to the individual state laws that govern specific accounts, many find this an attractive way of assuring that a child’s college tuition is paid for and allows an opportunity to provide for graduate school, if necessary. It is also a way to assure that money is not squandered before a child reaches a certain age.
With a UGMA account, on the other hand, the stipulations are a lot looser in that a child may access money in the account upon reaching 18 and use the money on whatever they wish. Sometimes this is used for college, while other times it is spent in less desirable ways than what the adult originally intended.
Weighing the pros and cons of tax-free gifting
With either account, it should be noted, however, that qualifying for financial aid will be more difficult for a child once they reach college age. So, this should be taken into consideration when the account is formed. As always, it is best to speak with someone qualified to explain these matters before investing, so that the adult establishing the account is aware of all of the benefits and drawbacks of doing so.
Tax-free gift options make investing easier
While the UGMA and the UTA were once wildly popular college investment and tax-free gift strategies, the introduction of the 529 Plan and the Coverdell Education Savings Account, have made them less so. However, they are widely available at financial institutions and are relatively easy to establish and to manage on behalf of a child. Investing in a child’s future is made easier when tax-free gift giving is properly understood.”
