If you are a parent or a grandparent, you're probably thinking about saving money and investing for your kids or grandkids' future. Maybe you want to save for their college education. Or maybe you just want to save now to give them a nest egg to start their independent life with when they graduate. You have two main options for the types of accounts to use for saving on behalf of a child.
UTMA / UGMA Accounts
A UTMA account is a "Uniform Transfer to Minors Act" account; a UGMA account is a "Uniform Gift to Minors Act" account. They are really the same thing, but different states call them one of those two names. When you create a UTMA or UGMA account, you name the child as the beneficiary and yourself as the custodian of the account. UTMA accounts convert to the child's control at age 21, UGMA accounts convert at age 18 (again, depending on the state). Contributing to these accounts is not reversable; you cannot take the money back out for your own use (or "ungift" it) later. Here's a more detailed explanation of the differences between these two closely-related account types:
Difference Between UGMA and UTMA
A downside of UTMA/UGMA accounts is that the income from the investments is taxable in the child's name. "Kiddie Tax" exemptions apply, so as long as the account doesn't earn too much income, it won't be a burden. But if the account generates a lot of income (dividends or capital gains), you will have to pay taxes on some of it.
What is the Kiddie Tax?
Here's more on the "Kiddie Tax" rules from the IRS:
Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)
An upside of these accounts is that the child can use the account for anything they want when it converts to their control (like their first house), or can be used for anything for their benefit (like college) before that age, if you (the account custodian) approve it.
Another good thing about these accounts is that you can create a UTMA/UGMA with nearly any broker or mutual fund company. So if you want to buy individual stocks or create a portfolio of mutual funds for your grandchild, this is probably the way to go.
529 Plans
A 529 Plan account is similar to a UTMA/UGMA account, except it has the advantage of letting the money grow tax free (like a Roth IRA), but the disadvantage that it must be used only for education expenses. Here's a primer on the basics of 529 Plans:
What is a 529 plan?
Ameliorating the education-only requirement, the account's value can be transferred to anyone else in the family if the child doesn't need the money. Say they are brilliant and get a full scholarship to college, you could transfer the account balance to their sibling's 529 plan, or you could even use it to go back to school yourself.
Another downside to this kind of account is that they tend to have limited investment options within the account. You might only be able to invest in a single target date fund, for example (that's the way it works for me in Maryland).
These plans vary from state to state. Your own state might offer you a tax deduction for contributing to one. If your child (or grandchild) lives in a different state, there might be advantages to investing in his or her state's plan instead. This link will help you find plans for various states:
529 Plans by State
Conclusion
Whether to invest through a UTMA/UGMA account or a 529 Plan can be a complicated decision, given all the trade-offs. Here's a link summarizing and comparing UTMA/UGMA vs. 529 Plans:
Quick Guide: 529 vs UGMA/UTMA
If you're confused after researching all the options, you might want to talk to a financial planner or tax advisor to decide which one is best for your situation.
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