A UGMA, (which stands for Universal Gift to Minor Account) is a custodial investment account that an adult can open for the benefit of any child. (Remember, for legal purposes, a child is defined as any person under the age of 18, not just someone who behaves that way.) A UGMA can be opened at any brokerage firm and most mutual fund families, and behaves just like a regular investment account with the following exceptions. First, only adults may make gifts of cash or securities, and only the custodian may place trades. (The kids themselves cannot place trades, though they certainly can participate in the decision-making process at home.) Also, all gifts made to the accounts are irrevocable, which is synonymous with "You ain't getting it back." This is not the place to speculate on penny stocks or day-trade either, you are prohibited from pursuing unduly risky strategies in an UGMA. Further, the kids are under no obligation to use the money for education or any other agreed-upon purpose when they get their 18-year-old hands on it. In fact, your very last responsibility as custodian is to re-register the account in their names when they turn 18. Once it becomes their money they can do what they like with it.
Taxes, as usual, can be a bit complicated. For the year 2001, the first $750 of any income in the account (dividend, interest or capital gains) is tax free. The second $750 is taxed at the child's tax rate, which is usually 15 percent. If the child is under 14 years old, then any income over $1500 is taxed at the parents' marginal tax rate. If the child is 14 or older, all income over $750 is taxed at the child's tax rate. Phew. Consult your broker for the specifics as it relates to your situation, as the tax picture may change going forward.
A final thing to consider: If you think you'll need financial aid for college, UGMAs can lead to smaller aid packages. The amount of money held in an UGMA is considered part of a student's assets. Typically, financial-aid administrators deem 35 percent of a student's assets available for college tuition, compared with only 5 percent of assets held by parents. So, if financial aid planning is on your radar screen, you may want to start socking away assets in your name instead.