Advanced Underwriting Consultants

Question of the Day – August 30

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Here’s the question of the day.

Question: Does an UGMA or UTMA account have special tax rules similar to an IRA or 529 Plan?


Answer: No.

For the most part, UGMAs and UTMAs don’t have any special tax rules; the accounts are merely a way of holding property, not a separate tax entity. Unlike 529 Plans and IRAs, there is no tax deferral. If an UGMA or UTMA owns a bank CD, the minor would have to report and pay tax on interest earned each year. If the account owns stocks or mutual funds and trades or sells them, tax would be due on any capital gains in the year of the sale or trade.

On the other hand, if the account owns a non-qualified deferred annuity (NQDA) and does not take a distribution, there is no taxation of earnings inside the contract. Likewise, if the account holds stocks and does not sell or trade them, there’s no current taxation.

The use of UGMA or UTMA assets does not affect taxation. For example, income earned by the account and used for college expenses is still subject to income taxes, unlike a 529 Plan. But the account is not subject to special penalties either; withdrawal from the account will incur no special penalty if the money is used for non-education purposes or prior to age 59 1/2 as in the case of, respectively, a 529 Plan or an IRA.

The UTMA or UGMA account gives no protection from penalties otherwise due. For instance, if the account holds a NQDA and money is withdrawn, the earnings portion will be subject to the 10 percent penalty for distribution prior to age 59 1/2. The fact that it’s in a custodial account offers no exemption from the penalty. This fact should be carefully considered prior to using a NQDA in an UGMA or UTMA.

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