When it comes to the rules and penalties for withdrawing college funds for non-college expenses, every account is slightly different. Here’s a breakdown of the rules, laws, and taxes associated with the three most popular college accounts.
UTMA and UGMA Withdrawal Rules:One of the oldest and most often used college accounts, especially before Section 529 plans were invented, are the UGMA and UTMA custodial accounts. These accounts allow adults to make a financial gift to a minor, and also name someone (including themselves) as the custodian of the account.
The important word here is “gift.” The money in these accounts, once given, is the legal property of the minor. The custodian’s job is to keep it safe and invest it wisely, so that the minor could benefit from it someday.
While that sounds strict, the rules define “benefit” fairly liberally. UGMA and UTMA accounts are often used to pay for college, but can also be used for any expense the minor incurs. This can include anything from basics costs of living to leisure activities like teams sports. You just have to be able to prove that the minor directly benefited from the use of the money.
Taxes and Penalties on UTMA and UGMA Withdrawals:Any profits made on the liquidation of investments in a child’s UGMA or UTMA account are reported on the child’s tax return. Some or all of this might be included on the parent’s tax return, at the parent’s tax rate, depending on how the family files their tax returns.
There are no IRS penalties on taking money out of a UGMA or UTMA account. However, it is possible that the investments purchased may have a surrender charge or exit fee if held less than a certain amount of time.