The misconception of UTMA and UGMA accounts: what you need to know

KJ: A bit shocking of a headline I imagine for anyone who has setup an UTMA or UGMA account for their son, daughter, niece, nephew, grandchild, cousin, whomever. In theory, I like the concept of an UTMA and UGMA account, but in reality, I think they are highly over utilized for what their intended purpose is.

Short for Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors (UGMA), it even says it in the name that it’s a gift or transfer TO the minor.

So, what is the misconception? With an UTMA or UGMA account, any money you gift to the account is considered an irrevocable gift to the beneficiary. That’s right, it is a gift of money (or investments) that you have given to a minor, and it’s up to a designated ‘custodian’ (i.e. generally the parent) who oversees the account on behalf of the minor until they are of age.

Sure, it’s a great way to potentially help set aside some designated funds for a minor, but once the minor reaches the age of majority (depends on the state, but it is either 18 or 21), then they legally have full control of the account to do whatever they may want to do with the account. Woah. Anything? Yep!

One nice feature is that you can use the funds for the benefit of the minor at any age (can be junior high, high school, college, etc.) for living expenses unlike a 529 plan that must be used for qualified higher education expenses. See also our post on into to funding education where we also talk about other higher education funding accounts and their pros/cons.

Figure Sitting And Reading Book With Idea Bulb Stock Image

An UTMA/UGMA becomes the child’s account
While traditionally common to help set aside some funds for education for a child, many parents don’t often realize that the account is legally the child’s to use however they would want once they reach a certain age. Plus, if the parent wants to recapture some of the funds (say it wasn’t all used for education or other support for the child), then it is up to the minor to actually gift the money back to the parents! Sure, a saving grace is often that the child probably has no idea how to access the funds unless the parent discusses it with them, but still. They might begin to wonder why they have a 1099 for an account in their name!

Taxation implications
There really aren’t too many positive income tax implications for an UTMA/UGMA. The first $1,000 of gains/income each year (for 2014) is tax-free, and the second $1,000 is taxed at the child’s tax rates (typically very, very low), but any gains above that are taxed at the parent’s income tax rates. It prevents parents from being able to shift a lot of assets to their child to avoid a higher income tax bracket.

Know the restrictions
While I’m not 100% anti-UTMA and UGMA accounts – in fact, we have one setup for my nieces – the person setting them up often doesn’t quite realize the implications for how the account can be used. For us, Angela and I wanted it to be used for whatever K&G may want when they get to a certain age – be it school, help with a car down payment, help with a house down payment, etc. We knew the implications of setting up the account and how it may ultimately be used beforehand.

Consider other options
Sure, these account types CAN be appropriate from time-to-time to help fund education for a child, and they can be appropriate for a parent truly wanting to gift some funds to their child to use however they want.

However, for those parents hoping to exclusively use it for higher education costs and to potentially “recapture” whatever may be left, there are much better uses of the funds. Maybe a 529 plan would be more suitable (where the donor continues to control the account after the beneficiary is of the age of majority), and if you wanted to gift the account back to yourself at the end of the time period, you generally can find a way to do so much easier (noting there could be some gift tax and income tax implications for earnings in the 529 plan account not used for higher education).

With a 529 plan, you can also reassign the beneficiary to another child, relative, etc. if the first child either doesn’t go to college or attends a less expensive college than you planned (woohoo for your budget!). Something you don’t have the ability to do with an UTMA/UGMA.

UTMA/UGMA accounts may impact financial aid options
One factor impacting your out-of-pocket education costs is eligibility for financial aid. A downside to the UTMA/UGMA accounts is that the value of an UTMA/UGMA account may reduce the child’s ability to receive financial assistance in college. In fact, it isn’t uncommon to see financial aid reduced by 20%+ of the value that is owned in an UTMA/UGMA.

    Do you have an UTMA or UGMA setup for anyone?
    What made you decide to open that account type?
    If you chose a 529 plan, why?

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How often do you look at your net worth?

Growing Dollar Tree Photo
KJ: How often do you look at your net worth? Weekly, monthly, quarterly, yearly, never? Why or why not?

I track our net worth on a monthly basis, and we review it together during our quarterly presentations. Yep, you read that right. For those of you who do not know us, we actually have a presentation that we review each quarter with information on investment performance, net worth changes, and other financial highlights for the quarter. We used to do a comprehensive cash flow each quarter, but since I’ve fallen behind on tracking it in Quicken, the numbers aren’t as reliable. Sure has a lot (or mostly all) of the information, but since we stay on top of our net cash flow each month, the quarterly figures aren’t as useful. It’s fun (and shocking) to look at periodically even if you know what you spend each week or month. There’s something about seeing some of the figures on a quarterly or annual basis that makes you wonder, “we spent how much at [insert retailer or restaurant]!?”

AJ: I know we’ve talked about our quarterly presentations before but looking at our net worth on a quarterly basis helps me understand where we are without getting too caught up in the tiny details that occur month to month. Ensuring we’re on track monthly helps keep us from having to catch up later, but I leave the monthly net worth review to Kirby so I don’t go crazy :).

Why track monthly?
So, why do I track our net worth monthly? Short and simple: to see if we’re on trend with our goals. It helps keep front of mind when we have a lot of goals that are very long-term in nature. Otherwise, it’s easy to let them slip by the wayside and lose sight of what the end goals may be.

Tracking it on a daily or weekly basis would probably make you go insane, but tracking it on a monthly basis still gives you the regular updates you need in order to stay on track. Plus, if you start tracking it regularly when you are younger, you’ll begin to learn how much investment performance and the whims of markets can impact an account in the short-term – a valuable lesson to learn sooner rather than later!

What do we track?
Well, everything we can think of to track that represents an asset we own except household valuables and furnishings. We include our house, cars, cash value life insurance, investment and retirement accounts, savings, etc.

What don’t we track?
For administrative simplicity, we don’t track jewelry, silver, furniture, furnishings, etc. in our overall picture. One-off expensive jewelry, art, wine, etc. could be included if you felt it were meaningful, but in most instances, it’s not something you would look to sell to raise cash anyways.

We also don’t track checking accounts or credit cards on our net worth. Since we keep relatively minimal amounts in our checking account from time-to-time other than to meet cash flow obligations, it’s not useful to show in our net worth figures. Same goes for credit cards, since we pay them in full each month, it doesn’t do any good to show the value. Technically, we could show the difference of the checking accounts and credit cards to come up with the net figure each month, but for simplicity, we do not. However, if you do have any type of credit card or loan balance that is carried over from month to month, then you would want to make sure it is properly included (i.e. reducing your net worth).

How do we get values?
Some items are easy to value like your 401(k) or investment accounts that have regular daily values. These most often come from online account summaries or statements that are easy to access. Try to use the same date for valuations, otherwise you might be double-dipping! If you have a deposit or transfer in transit, you could be including it in the value of the receiving account, yet it still hasn’t been deducted from the sending account, so make sure you’re not overstating a value.

Other items like a home and cars are a little less easy to value.

I try not to make any adjustments to the value of the house unless a meaningful event has happened (mostly a significant decline in prices in the neighborhood like 2008 and 2009 showed most of us), but I seldom increase the value of our home. In fact, I even take off 6% of the estimated value to show the true, net estimated costs of selling with all the realtors fees and transaction costs involved if we were to sell it.

For the cars, probably about once or twice per year I’ll head on over to Kelly Blue to check out the current values of our cars. They don’t change a whole lot, but it’s good to be realistic (and conservative) about the values we’re showing them at, so I usually round down.

If we had business interests, we would include that, but we don’t at this point in time. That part of your net worth may be the most tricky to value, and it is likely to be infrequently valued (probably at most once per year).

Do we use after-tax figures in our net worth?
The short answer is no, but if you really think about it, shouldn’t you show the after-tax value of your retirement accounts? Seeing as how we’ve tried to put as much as we can in Roth accounts, they’re essentially after-tax funds anyways, so we don’t make any adjustments. However, Angela has a 401(k) that is pre-tax that we could consider reducing by our tax rate. Maybe this will be a change we make going forward, but this has just added one more step in complexity to tracking it, so I haven’t taken the plunge to make the adjustment to show our after-tax net worth specifically. It’s really not difficult to do, and I would highly encourage you to make the adjustment particularly if it’s a very significant part of your net worth.

Take the value of your account and multiply it by (1-Tax Rate). So, if you’re in the 25% tax rate, and your account is $10,000, then you would take $10,000 (1 – 0.25) to get a result of $7,500 to show on your balance sheet. A pretty meaningful adjustment though when you think of the impact on a large pre-tax account!

    How often do you look at your net worth?
    Do you exclude the value of anything from your net worth?
    Do you look at the after-tax figures?

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The simple secret to building long-term wealth

KJ: So, here goes. The simple secret to building long-term wealth. A strategy so simple, how can it possibly be true? Is it a genius idea, is it working 70+ hours per week, eliminating your weekends from your personal life, is it abandoning all fun in your life? Nope. The simple truth is that you only need two very important, but very basic things: time and discipline. While that super genius invention that everyone in the world will need to use combined with your expert business savvy could be factors that get you there; chances are that isn’t likely the path for you (or most everyone in the world out there).

We’ve written about this before, but time is one of the greatest assets available when you’re saving for your goals – especially very long-term goals like retirement. Really, the compounding effect of interest over time is amazing. It’s all about putting your savings to work for you over time, and the longer it’s at work, the more and more beneficial it is for you. Don’t believe it…just look at the chart below on how time can work in your favor.

JP Morgan Investing Early and Compounding Interest Over Time

It’s never too late to start though, so stop putting off your goals and savings until a time when you will have fewer expenses. Don’t delay, and start today!

Now that you’ve got step one of two down on this list to building long-term wealth, it’s time to work on your discipline. And, one of the easiest ways to build savings discipline in your family’s budget is to make it both automatic and calculated, so you don’t even have to think about it.

Have your savings (retirement, travel, emergency fund, etc.) siphoned off each month at predictable times. That way, you make savings part of the rule and not the exception. Your net worth will thank you over time by making your savings systematic. When you don’t have it at your disposal to spend each day, week, or month, you’ll be amazed what you and your family can live on (or without!).

Live below your means. We don’t spend as much time talking about this as we do actually living it, but getting a raise doesn’t equate to increasing your budget. It equates to retiring earlier. Find a comfortable financial station that you and your family can reasonably live with and stay there even as you build your earning potential well beyond that point. I won’t judge your 15 year old car if you won’t judge me for retiring at 45.

Set specific financial goals. Think about what your savings needs are to achieve your goals – whether it’s a house down payment, vacation travel fund, or an emergency fund – and figure out how long you have to accomplish them. Some goals may vary on the exact timing, but that shouldn’t stop you from estimating when you think you may need those funds. Just do a few simple calculations, and see if your timing and goals are realistic. If you need $10,000 for a goal one year from now, but you only have $100 per month to save toward that goal, chances are it’s not going to happen in your original timeline! So, be specific on what you need to save.

    What strategies have worked for you to build you and your family’s net worth over time?
    What are you doing to get time on your side?
    What disciplined savings habits work for you?

The simple secret to building long-term wealth is copyrighted by without consent to republish.

Some of the links in the post above may be affiliate links. This means if you click on the link and purchase the item, we will receive an affiliate commission. We feel strongly about only recommending products or services we use personally and/or believe will add value to you, our readers. Read more about our commitment to providing quality product recommendations.

Why you need an emergency fund

Emergency fund 101KJ: So we had a bit of a real-life experience this past week on the importance of funding your emergency fund. Not only do you never know when you will need to dip into it, but you don’t know how quickly you may need access to it either. Plus, money is the last thing you need to be stressed about when dealing with an emergency. So, how then do you make sure you have enough money in your emergency fund for when you really need it? We’ve written about it quite a bit over the last couple years of our blogs, but this past week really hit home on the WHY we save like we do. Not only was our recent dip into the emergency fund stressful and woefully unexpected, matters would have made the situation worse had we not been prepared financially when it came time to pay the piper. Hey, just because you’ve built up your emergency fund doesn’t mean it’s any less painful to spend it when the time comes! Let’s start with some information on what an emergency fund is, what it isn’t, and what you should do to protect you and your family in an emergency situation.

What is an emergency fund?
Any good emergency fund should have the following characteristics:
It should be highly accessible. Don’t plan on equity in your home to serve as your emergency fund. That’s a terrible idea as people saw firsthand in the 2008-2009 real estate bubble bursting. But, your emergency fund should be invested in highly accessible cash, be it a money market account or a savings account. Once you’ve built up your various buckets, for the first $5,000 of your core-emergency fund, don’t bother trying to do anything fancy with Certificates of Deposit (CDs) or any investment product at a brokerage firm with today’s low interest rates. You NEED it to be highly accessible and penalty free when you’re in a bind, so having the flexibility in just a regular savings account is often preferable.
It should have a minimum of $1,000 quickly. It should be filled with at least $1,000 to get started right away, but it should be built up with enough funds to cover your home, health, and auto deductibles should something crop up unexpectedly (not quite as rare as you may think!). Then, look to build it to that magical 3-6 months of your living expenses, so it can serve that additional purpose in the event of a job loss.
It should be reserved for emergencies ONLY. This one is plain and simple. Don’t use this for when that TV of yours breaks, upgrading appliances, or taking a trip. Hold strong and use it for its intended purpose!
It should protect you and your family. Any good emergency fund should be able to provide your family with the cash you need, so you don’t have to rely on high interest credit cards or lines of credit. Those just add fuel to the fire and make your emergency situation just that much more difficult to dig out of.
It should provide peace-of-mind. Once you’ve saved the proper amount, your emergency fund helps take the added financial stress out of the situation. The last thing you need to stress about when dealing with a health, home, or auto emergency is the financial aftermath, so why make the situation worse. It’s easy to get behind, so dig your heels in and get ahead before it’s too late.
A way to ensure you won’t be a burden to your family. This is particularly important to us in an emergency, as what you need most from family is emotional support and not financial support. An emergency fund protects both you and your loved ones.

What an emergency fund is NOT.
It is not to be used for regular living expenses. As in the above writing, don’t use it for everyday needs. Oh, my checking account is low, or, I need a better pair of shoes. NO! If you find yourself wanting to dip into the account for these purposes, then head on over to our earlier post on finding a surprisingly free (and simple) budgeting tool to give your budget a quick start, so you can quick-stop your reliance on your emergency fund for every day use.
It is not illiquid. Don’t rely on real estate, rental real estate income, or investments to be your core emergency fund. Sure, over a VERY long period of time, you could come out on top if you could eek out a little extra return, but the lack of flexibility when you need the funds most can be a huge issue.
It is not pushed aside and never looked at again. Just because you have built up your emergency fund one year, doesn’t mean it will forever be the same amount your family needs. Periodically check to see if there may be more you need to save up. Maybe your expenses are higher or your risk factors for health issues have increased, meaning you need a higher balance in your emergency fund. Again, start with $1,000, then build to $5,000, then build to 3-6 months of living expenses.
It isn’t a planned expense. An emergency fund is for just that: an emergency. Don’t use it to fund a known expense coming up for a roof replacement, new fence, etc.

So, how then do you plan on using your emergency fund?
Have quick, direct access to your account to transfer funds to a checking account. If it takes multiple days for cash to be available and is at another institution than your checking account, that can be troublesome at times.
Know how and where to go. Don’t bottle this up and keep information from your significant other. Make sure both of you know how and where to go to raise funds as needed. It doesn’t help to have saved the money and have it available if you don’t both know what to do. Think of it as a little at-home cross-training.
Lean on your everyday credit card. This one carries a big caveat, but if you have properly built up your emergency fund, then simply putting the expense on your credit card, and then subsequently transferring cash to your checking account to payoff the bill ASAP can be an a-okay solution. We wouldn’t have been able to do this recently had we just graduated from college, but as we’ve continued to build our credit, we’ve increased our access to credit too (actually quite scary what the credit card companies think is OKAY to have access to!! But, we’re responsible, so we’re not racking up ANY credit card debt in the process that isn’t paid off in full each month).

    Do you have a fully-funded emergency fund?
    What amount do you need for your emergency fund?
    Don’t delay, and start an emergency fund today!

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Some of the links in the post above may be affiliate links. This means if you click on the link and purchase the item, we will receive an affiliate commission. We feel strongly about only recommending products or services we use personally and/or believe will add value to you, our readers. Read more about our commitment to providing quality product recommendations.