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Saving for Future Education
Saving for a child's college education involves research and careful planning. A 529 savings plan, Uniform Transfer to Minors Act (UTMA), or Uniform Gift to Minors Act (UGMA) accounts offer well-established savings tools. All three options achieve similar goals, with some differences. This page explores some of the characteristics, benefits, and differences of a 529 vs. UTMA/UGMA. Parents and custodians can use the information to determine which one best matches their financial goals.
What is a 529 Plan?
Savers choose between two 529 plan types: educational savings plans or prepaid tuition plans. The Securities and Exchange Commission notes that all 50 states and Washington, D.C. sponsor at least one of these plans.
Parents open an educational savings plan to fund a minor's future college education. The investment account can only pay for tuition, fees, and room and board. They can use the money to pay for any U.S. school, and some overseas too. Parents can use up to $10,000 for elementary or secondary school education. State governments sponsor all education savings plans, and few stipulate residency requirements for the holder and/or beneficiary.
A prepaid tuition plan requires buying credits or units for future higher education at participating schools. The beneficiary can only use the money for tuition and fees. The plan does not cover the cost of college room and board or elementary and secondary education. State governments sponsor most prepaid tuition plans, and they do involve residency requirements.
Benefits of 529 vs. UTMA or UGMA include tax breaks on in-state plans. Other benefits include the option to change beneficiary within the family, and controllership that stays with the owner. Conversely, they only hold cash contributions and investments created specifically for the 529 plan.
What is a UGMA/UTMA Account?
UGMA and UTMA classify as custodial accounts that an adult controls for a minor. Each functions like an account at a bank or brokerage firm. UGMA and UTMA accounts differ in what assets they can hold. UGMA only allows contributions of cash or securities. UTMA allows contributions of gifts and the transfer of any property benefiting the minor. Property transfers can include works of art and real estate. All 50 states allow UGMA accounts. As of 2020, Vermont and South Carolina do not allow UTMA accounts.
Let's break down UTMA and UGMA vs. 529 accounts. Custodial accounts provide greater flexibility than 529 plans, with no limits on financial or asset contributions or withdrawals. They offer a simpler and cheaper way to transfer assets to a minor compared to a trust fund.
The negatives include no possibility of reversing contributions made into the account. Also, once beneficiaries come of age, they retain control of the account. A UGMA or UTMA can also hurt a child's prospects of securing financial and other government aid. Savers get less tax benefits for UTMA/UGMA vs. 529 plans.
How Are 529 Plans and UGMA/UTMA Accounts Different?
UGMA/UTMA accounts and 529 plans provide different levels of flexibility in what assets they can hold and how beneficiaries can use them. These differences impact factors such as financial aid eligibility, income tax benefits, and account ownership. This section delves deeper into why the differences between 529 vs. UTMA and UGMA matter.
Financial AidStudents applying for financial aid must fill out the FAFSA. The FAFSA looks at a number of factors, including child and family assets, to determine the applicant's eligibility. Applicants report UGMA and UTMA accounts as a child asset, which significantly reduces their aid eligibility. Conversely, 529 plans count as a parent asset, with low impact on aid eligibility.
Income TaxBoth kinds of accounts provide tax advantages. A 529 plan provides a better tax advantage because it allows assets to grow tax free. It incurs no taxes on withdrawals for qualified higher education expenses. Many states offer income tax breaks for contributions to 529 plans. These deductions can serve as tuition discounts. Conversely, custodians must pay annual taxes — called the Kiddie Tax — on earnings in UTMA and UGMA vs. 529.
Gift TaxAny contribution to a 529 gift plan counts as part of the contributor's annual $15,000 gift tax exclusion. Merrill Lynch notes that contributions over $15,000 count toward the lifetime federal gift tax exemption or federal gift tax. Donors can contribute up to $15,000 annually per individual into a UGMA or UTMA without incurring a gift tax.
ContributionsFederal law stipulates that 529 plan contributions cannot exceed the projected cost of the beneficiary's higher education expenses. The maximum contribution for 529 plans vary by state. States establish no contribution limits for UGMA/UTMA accounts.
Qualified ExpensesParents should consider the limits on what qualifies as a legitimate use of 529 money. Qualified expenses include tuition and fees, room and board, and books and supplies. Repayment of student loans also qualify as expenses that incur no penalties and taxes for 529 plans. Beneficiaries and custodians can use UGMA and UTMA accounts for many non-educational expenses.
Account OwnershipAdults serve as custodians of UGMA and UTMA accounts for minors. But once minors reach age 18 or 21, depending on the jurisdiction, they control the account. Adults retain control of 529 plans regardless of the beneficiary's age.
Choosing Between a 529 Plan and UGMA/UTMA Account
Parents and other guardians choose 529 plans to establish an account that minors can use solely for their education. If the donor wants control of the account no matter the beneficiary's age, a 529 remains the best option. It also provides greater tax benefits than UTMA and UGMA accounts.
Custodians can open UTMA and UGMA accounts for education and/or other expenses. These accounts offer transfer of wealth to a minor without the expense or complications of a trust fund. But once the minor reaches age 18 or 21, the custodian can no longer control the account. They also cannot transfer assets to another beneficiary like a 529 plan allows. Furthermore, the law allows transferring funds from UTMA and UGMA accounts to 529 plans, but not vice versa. Parents who can afford it can open a 529 plan and custodial accounts.
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