What’s the Best College Account–529 or UTMA?
When planning for your wingmen’s education expenses, two investment accounts come into consideration: 529 College Savings Plans (529s) and Uniform Transfers to Minors Act (UTMA) accounts (Some states still use a dated cousin called an UGMA—Uniform Gift to Minors Act). Each offers benefits and drawbacks, and while most families will max perform their money with a 529, UTMAs have a role at the merge too.
529 College Savings Plans 101
529 accounts are state-sponsored, tax-advantaged education saving accounts. Each state offers at least one, and you don’t have to be a resident of that state to use their plan. Here’s the 411 on 529’s:
- Tax Advantages: Contributions to a 529 plan grow tax-deferred, and withdrawals for qualified education expenses are tax-free at the federal level. Some states also offer tax deductions or credits for contributions.
- High Contribution Limits: These plans typically have generous lifetime contribution limits, often exceeding $300,000, allowing for substantial savings over time.
- Control Over Funds: As the account owner, you retain control over the funds, including the ability to change beneficiaries to another qualifying family member if the original beneficiary doesn’t need the funds.
- Financial Aid Considerations: Assets in a 529 plan are considered parental assets on the Free Application for Federal Student Aid (FAFSA), which generally has a smaller impact on financial aid eligibility compared to student-owned assets.
- Grade School Use: Up to $10K per year can be used on Kindergarten through 12th grade private school expenses and up to $10K can be used to repay student loans too.
- Roth IRA Rollover: Funds left in a 529 after 15 years can be rolled over to the beneficiary’s Roth IRA, subject to several limitations.
529s aren’t all sunshine and lollipops, though:
- Withdrawals must be used for qualified education expenses to enjoy tax-free benefits. Non-qualified withdrawals are subject to income tax on the earnings (not original contribution) and a 10% penalty on earnings.
- Investment Options: 529 plans offer a limited selection of investment options, which may not satisfy all investors’ preferences or risk tolerances.
- Potential Fees: Some plans have high fees or sales charges, which can erode investment returns over time.
- Plan restrictions: Some states restrict the transfer of ownership prior to the death of the original owner. Other states consider a rollover to another state as a taxable, non-qualified withdrawal, even if you never paid taxes to that state.
UTMA 101
At their core, UTMAs are tax-advantaged but taxable brokerage accounts that families usually use as wealth-transfer tools. However, they can also be part of college funding.
Benefits of UTMA accounts include:
- Flexibility of Use: UTMA accounts allow funds to be used for a wide range of expenses benefiting the minor, not limited to education.
- Broad Investment Choices: These accounts can hold various types of assets, including stocks, bonds, mutual funds, and real estate, providing greater investment flexibility.
- No Contribution Limits: There are no specific contribution limits, though large contributions may trigger federal gift tax implications. (Which rarely affect most families.)
Reasons to skip or delay funding a UTMA could be:
Tax Treatment: Earnings in a UTMA account are subject to taxes annually. The first $1,350 of unearned income is tax-free, the next $1,350 is taxed at the child’s rate (could be 0%), and amounts over $2,700 (2025) are taxed at the parent’s rate, due to the “kiddie tax” rules. (If the investment in the account is a non-dividend paying stock, then annual income without any sales could be $0.)
Impact on Financial Aid: UTMA accounts are considered assets of the student on the FAFSA, which can reduce financial aid eligibility, as student assets are assessed at a higher rate than parental assets. (Note that if you have enough assets to be transferring wealth to your kids, there’s a good chance they aren’t getting need-based financial aid anyway.)
Irrevocable Transfer: Once assets are transferred into a UTMA account, they become irrevocable gifts to the minor. Upon reaching the age of majority (which varies by state), the beneficiary gains full control over the funds and can use them at their discretion, regardless of the original intent.
Which Should You Choose?
If you’re certain the funds will be used for education, a 529 plan’s tax advantages are compelling. However, if you desire flexibility for the funds to be used for other purposes, a UTMA account offers broader options.
With a 529 plan, you maintain control over the account indefinitely. In contrast, a UTMA account transfers control to the beneficiary at the age of majority, which may be a concern if you’re unsure about the beneficiary’s financial responsibility at that age. Why risk pouring gas on a fire?
Consider your current tax situation and the potential impact of each account’s tax treatment. While 529 plans offer tax-free growth for education expenses, UTMA accounts may result in annual tax liabilities due to the kiddie tax.
Funds in a 529 cannot be donated to charitable organizations, so there is some risk of dollars being “trapped” in the account.
Financial Aid Impact: Reflect on how each account type will affect financial aid calculations. Since UTMA accounts are considered student assets, they can have a more substantial negative impact on aid eligibility compared to 529 plans.
Cleared to Rejoin
The flexibility of 529 plans has grown in recent years, and if Congress allows excess funds to be donated in the future, they will become even more helpful for high-earning families. Given the 15-year clock for Roth IRA rollovers, most families will benefit from a “minimum viable funding strategy” by starting with 529 funding. As the 529 balance grows and the kiddo’s college trajectory starts to take shape, a switch to UTMA accounts can make sense to create flexible, tax-advantaged additional funds.
Fight’s On!
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