mong the alphabet soup of investments, the custodial accounts under the Uniform Gifts/Uniform Transfers to Minors Acts (UGMA/UTMA) are relatively easy to spell out and to establish.

Whether you plan to use the account for college savings, estate planning, or simple gifting, here are some questions about the accounts to keep in mind.

If you're
making the gift,
assign custodianship
to someone else.
What are the Uniform Gifts/Uniform Transfers to Minors Acts? How do they differ?
The Uniform Gifts and Uniform Transfers to Minors Acts are statutes that allow you to transfer assets to minors. Under the statutes, an adult, called a custodian, manages the assets in an account until the child reaches a specified age. (That age varies from 18 to 21, depending on the state in which you reside.) At that time, the account terminates and the custodian transfers the money to the child, who can spend it as he or she chooses.

The Uniform Transfers to Minors Act, the more recent statute of the two, allows you to transfer a broader range of assets to a minor. In addition to stocks, bonds, insurance policies, and bank deposits, UTMA allows you to pass along partnership interests, real estate, and royalties, among other assets. All states have adopted UGMA, and all but South Carolina have adopted UTMA.

How can I establish an UGMA/UTMA account?
The account is quite easy to establish. Decide which assets you'd like to transfer and whom you'll name as custodian. Then fill out an application for a custodial account at your credit union or brokerage firm. "The application is similar to setting up a joint account with a spouse," says Robert Tull, a certified financial planner in Chesapeake, Va. "You'll include the Social Security number of the child and the name of the custodian."

The account will be designated with language along the lines of: "John Doe, as custodian for Jane Smith, under the Illinois Transfers to Minors Act."

From that point on, property held in the custodial account is considered, by law, to be the child's. Even though the child will not control the account until years later, he or she owns the property from the moment it's transferred into the account.

"The account is irrevocable," says Tull. "You can't change your mind and move money back out of the account, even if the child decides not to go to college."

What is the custodian's responsibility?
The custodian assumes all financial responsibility for the account. He or she manages and invests the assets and files the necessary paperwork. The custodian alone has the discretion to spend funds, which are solely for the use and benefit of the minor.

Who can be a custodian?
You can name anyone as custodian: a grandparent, sibling, a lawyer, even yourself. However, there are estate considerations that may influence your choice.

Many people establish the accounts to transfer money out of their estate. If you're the person making the gift, it's better that you assign custodianship to another person. For if you retain custodianship and die before the child is of age to take over the funds, the account is included in your estate—just what you wanted to avoid in the first place.

If you insist on being custodian, be sure to name a successor. Some states allow you to designate your successor custodian on the account application. Otherwise, you can do so in your will.
    Once the child
    comes of age,
    he or she has
    access to the funds,
    no matter how
    financially responsible
    he or she may be.

Custodial accounts
significantly reduce
a student's eligibility
for college
financial aid.
How does an UGMA/UTMA custodial account differ from a trust?
Trusts are more formal and complicated than custodial accounts. "A trust is more expensive because a trust agreement must be drawn up by an attorney," says Linda Hirschson, an attorney and estate planner with Greenberg Traurig law firm in New York City. "A trust is a separate entity, so it has its own tax identification number. For a custodial account, it's held in the child's tax ID number, his Social Security number.

"Trusts also give more flexibility to the custodian to withhold or pay out funds," says Hirschson. "You can hold the funds as long as you want. But with a custodial account, ownership and control must pass at age 18 or 21."

How is an UGMA/UTMA taxed?
According to Tull, the first $700 in income on a child's investment is tax-free. If the child is younger than age 14 as of Jan. 1, 2000, the income between $700 and $1,400 will be taxed at the child's tax rate, which is usually 15%. Then, if the income is more than $1,400, it will be taxed at the parents' rate.

If the child is older than 14, all income more than $700 will be taxed at the child's rate.

How does an UGMA/UTMA affect a student's eligibility for college financial aid?
"They significantly reduce students' eligibility," says Kalman Chany, author of "Paying for College Without Going Broke 2000 Edition" (ISBN 0375754679). "Since a custodial account is held in the child's name, it's assessed up to 25 or 35 cents on the dollar (in the aid calculations). Depending on the formula, parents' funds are assessed a maximum of five-and-one-half cents on the dollar. If you're contemplating applying for need-based financial aid, avoid those plans."

What are the pros and cons of an UGMA/UTMA custodial account?
UGMA/UTMA custodial accounts are a free and easy method for making a financial gift to a child and for transferring funds out of your estate.

"It segregates your money, so it can't be reached by your creditors," says Adriane Berg, editor of Wealthbuilder: A Family Financial Newsletter and author of "Gifting To People You Love" (ISBN 155704273X). "The money no longer belongs to you. It belongs to [the] child."

Because the account is taxed at the child's rate, you also may receive a tax break.

However, these accounts have their drawbacks. Again, the account is irrevocable. Once you've transferred money into the account, you cannot change your mind and withdraw it. And once the child comes of age, he or she has access to the funds, no matter how financially responsible he or she may be.

As such, custodial accounts usually work better for smaller sums. "It's probably best for small annual gifts where the funds will supplement college," says Tull. "For larger sums, you should establish a trust. Then you can put controls on the trust and defer payment until much later."

What other investments should I consider?
Evaluate your financial goals. Need to reduce your estate? Consider trusts and the annual gift exclusion, which allows you to give up to $10,000 per person each year.

Saving for college? Take a look at IRAs, education trusts, or the 529 program, a new federally established program in which states partner with brokerage firms to offer college savings plans. Or consider paying educational costs directly. "It doesn't count against the $10,000 annual gift exclusion, and it's paid directly to the educational institution," says Hirschson.

Above all, invest time in talking to your children about money. The most common fear with UGMA/UTMA accounts is that the child won't have the skills to properly manage the money once it passes to them. It's up to you to erase that fear and replace it with knowledge. "You can't expect teenagers to hit 18 and suddenly be financially literate," says Tull. "So teach your kids while they're young how to manage money."

© 2000 Credit Union National Association Inc.