wpu-education-700x300.jpg

Key takeaways:

  • Uniform Transfers to Minors Act (UTMA) accounts and 529 plans are two key vehicles that can help supplement college savings and can be an important part of your gifting strategy.
  • Although UTMA accounts are often associated with educational expenses, an UTMA is not an educational savings plan.  The beneficiary may use the assets in the account as they see fit (once the beneficiary reaches age of majority). Investment options are relatively flexible.
  • 529 accounts are for educational purposes and have fewer investment options but may offer more flexibility if you want to change beneficiaries and for annual gifting.

What it may mean for you:

  • Determining how you want the funds to be used in alignment with your goals is critical when deciding whether an UTMA or 529 plan is the right choice for you and your beneficiaries.

Many parents want to assist their children (and grandchildren) with college expenses. There are a number of options to help finance a college education, including a type of custodial account named after the Uniform Transfers to Minors Act (UTMA) and 529 plans. Parents thinking about either of these two approaches should carefully consider which alternative is best suited for their situation.

UTMA vs. 529 Plans: The basics

There are many reasons to set up an UTMA account for a minor child. Primarily, an UTMA enables parents or account custodians to transfer funds and property to minor children without establishing a trust.  It’s also an estate planning vehicle that can be used for educational purposes.  An UTMA is ultimately the child’s, and the assets in the account can be used for a variety of expenses beyond education, such as purchasing a laptop or funding attendance at a special camp. The attractive features of an UTMA include being able to take advantage of the annual gift tax exclusion and greater flexibility with investment options.  

If you overfund the UTMA that you intend to be used to pay for education expenses, the child can use the additional funds for whatever purpose they choose when they reach the age of majority. For some individuals, this ability may be problematic. The donor may worry about the impact of the UTMA assets on the child, if they have not prepared the child for the access to those assets. Will it demotivate them?

If you have already set up an UTMA, in certain circumstances there may be options to modify use of funds for the beneficiary. We recommend discussing such potential solutions with your financial and tax advisors.

There are no concerns about money being used for financing for anything other than education if you opt to use a 529 plan. A 529 plan is established for the beneficiary, but the donor is the account owner. The donor can contribute after-tax dollars, and the contributions have the potential to grow tax-free. Withdrawals are tax-free if they are used to pay for qualified education expenses for the account beneficiary—your child, grandchild, or other beneficiary. An attractive feature of a 529 plan is that the donor may make a lump-sum contribution of up to $75,000 for 2019—five times the annual gift tax exclusion amount of $15,000 per individual, provided there are no other gifts made to the same beneficiary during the five-year period. In addition, a portion of the contribution amount may be included in the donor's taxable-estate calculation if he or she should die within the five-year period.

A potential downside is that investment options associated with the specific 529 plan for your state may be limited. In addition, withdrawals or earnings are subject to a 10% penalty and taxes if the funds are used for nonqualified expenses.

Key considerations for an UTMA and 529 plan

Before deciding to fund an UTMA or 529 plan, it is important to understand the tax and other considerations of both types of accounts. While both UTMAs and 529 plans can be used toward college savings, here are some important considerations:

  1. Tax implications: Since UTMAs are considered the child’s asset, a portion of the earnings is tax-exempt, and a portion may be taxed at the child’s rate, called the “kiddie tax.” In contrast, the earnings on a 529 plan are tax-free, and qualified withdrawals are exempt from federal taxes.
  2. Account ownership: For an UTMA, the parents or account custodian control it only until the child reaches the age of majority (which varies from state to state). At this point, the parents or other custodian have no say in how these funds can be used since the gift is irrevocable. In contrast, the account owner controls a 529 plan account, and if the beneficiary no longer needs the education funds, the owner can change the beneficiary to another qualified family member.
  3. Impact on financial aid: The child is the ultimate owner of the UTMA account, which may reduce financial aid eligibility. But with 529 plans, the assets are considered the parent’s (or the custodian who set up the 529) and, therefore, are not counted as part of the child’s resources for determining financial aid.

Before setting up a college savings plan, consider how the assets likely will be used and work with your financial and tax advisors to determine the appropriate option for your situation.

Please consider the investment objectives, risks, charges and expenses carefully before investing in a 529 savings plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest

Author: Karen Josephson, Senior Wealth Planner

View a PDF version of this report