Military Finances 301: Don't Forget to Tend to Your UGMA Garden
Investment TaxesI'm not much of a gardener. My Dad grew up on a farm and he tried to teach me about growing stuff. I didn't pay much attention (jets were a lot cooler). But I did learn that you need to tend to your garden if you want things to grow the way you want them to.
Much the same, you need to tend to your UGMA (Uniform Gift to Minors Act) or UTMA (Uniform Transfer to Minors Act) accounts. O.K. Official end of metaphors (or was it a simile?).
Many of us set up UGMA or UTMA accounts for our kids or grandkids. We deposit some money, make some investments and let them grow. We don't do much else. Should we?
Harvesting Gains in UGMA/UTMA Accounts is a Good Idea
If you could make money and not pay taxes on it, would you? You almost certainly can do so with the money in an UGMA or UTMA account. That is because the beneficiary of the UGMA/UTMA account often has a 0% Long-Term Capital Gains (LTCG) tax rate.
Figuring out How Much LTCG's You Can Harvest Tax-Free
First of all, your child's/grandchild's investment income isn't reported on your tax return. It's reported on their tax return (in certain circumstances you can elect to report on your return...doesn't normally make sense). Since the income is reported on the beneficiary's tax return, he or she will have a standard deduction.
If the beneficiary only has investment income (normally interest, dividends and capital gains) he or she has a standard deduction of $1,350 (in 2025). the amount is adjusted for inflation). Said another way the first $1,350 of investment income is tax free. But wait there's more!
The next $1,350 is taxed at the child's tax rate. And here's the cool part. If that $1,350 is LTCG, the child's tax rate will be 0%. So assuming there is little to no interest or dividends you should be trying to harvest $2,700 (2025) in gains each and every year the UGMA/UTMA is open. This will save a minimum of $405 per year in future taxes. Obviously, if there are dividends or interest, the amount of LTCG to harvest decreases.
It's also worth noting that if the child has earned income, the deduction you can assign to investment income is much smaller.
The Gotcha
You do need to pay attention though. If you go over the $2,700 limit, the income is taxed at the parents' tax rate and that probably isn't 0%.
Increasing the Likelihood of Harvesting 0% Capital Gains
One thing that can mess up this plan is large capital gains distributions from a mutual fund. One way to avoid this, and increase your ability to harvest 0% LTCG, is to invest in ETFs instead of mutual funds. ETF's do not generally distribute capital gains and will allow you to harvest more gains.
Also, the earlier you start this the better.
Tend to your garden. Tend to your investments and taxes. Your results will almost always be better.
Military Finances are Different
UGMA gardens are the same for all taxpayers. That isn't always the case though. As an Active or Retired Servicemember you have unique planning and tax issues. That's why we think Senior Military Officers and NCOs should work with a financial planner that deals with your unique military related benefits and issues each and every day. If you'd like to find out how we help people just like you, use the button below to schedule a free, initial consultation.
If you found this article useful, you might like the following blog posts:
Retired Military Finances 401: IRA Considerations in the Year Dad (or Mom) Passes Away
Retired Military Finances 101: No. Your VA Disability Benefits Can Affect Your Income Taxes
Military Finances 401: UPREITs