Financial Planning:
529 Plan or UTMA Account?

If you’re like many people, you want to start gifting money or assets to children or grandchildren for college and other needs.  What’s the best way to do that?  This article will look at two common options:  the 529 plan and the UTMA (Uniform Transfer to Minor’s Act) account. 

First, the basics of these two strategies:  a 529 Plan is a tax-advantaged plan designed to encourage saving for future educational costs. [i] A UTMA is a custodial account established to benefit a minor. [ii]  Both these strategies provide a way for you to help pay for a child’s education.  Both can cover tuition and expenses for college, private elementary and secondary school education.

The similarities, however, stop there. 

What would you like the money to be used for? 

When you’re giving a gift, you might want to specify how the funds will be used.  One big difference between these two accounts: a 529 plan can be used only for qualified education expenses.  On the other hand, the UTMA can be used for non-educational purposes.  So the UTMA has much more flexibility in that regard. 

What are the tax benefits?   

Unfortunately, with both accounts, contributions are after-tax, so there’s no tax benefit for you.  But there are for the recipient. 

The 529 plan is a tax-advantaged account.  Investments in the account grow tax-free, and withdrawals for eligible educational expenses are not subject to federal tax as long as you follow the plan regulations.  (Although most states also do not tax withdrawals, please note some states may treat withdrawals differently.) 

The UTMA account is not tax-advantaged.  Because contributions are after-tax, withdrawals of contributions are not taxed.  Investment earnings are taxable but at the child’s tax rate, which will likely be much lower than the parents’ tax rate. 

Who controls the account? 

With the UTMA account, you as a gifter don’t necessarily have control over the money.  You will initially name a custodian who will decide how to invest the assets and how any distributions may be used to benefit the child.  That custodian may be you or a parent.  But once the child turns the age of majority (which will usually be 18 or 21, but will depend upon the state they reside in), the beneficiary gains control and can spend the money however they like.  Yes, even if it’s for a sports car or a jet ski. 

The 529 plan gives you as a gifter more control.  The person who opens the account maintains control regardless of the beneficiary’s age.  You can even switch the beneficiary to another child in the same family if the first child doesn’t need all of the money (subject to some limitations). [iii]

How do you choose the right plan?

So which one is right for you?  As with most financial strategies, there is no one-size-fits-all answer.  It is a matter of finding the right one for your needs.  Here’s a summary of the pros and cons of each to help you decide.

529 Plan

Pros:

• Ideal for education and ensures your money is spent only for that purpose.
• You maintain control over the account.
• The money grows and is withdrawn tax-free as long as the rules are followed.
• If one child doesn’t need all the money, it can be switched to a family member.
• If titled in the right way, the account will not have a significant impact on the child’s ability to qualify for financial aid.

Cons:

• Contributions may only be made in cash.
• Limited to education-related expenses.
• There are no limits on distributions for qualified higher education expenses, but there is a $10,000 per year limit for elementary or secondary school tuition.

UTMA

Pros

• Can be used for any type of expense (not just education).
• Contributions can be made in cash or a wide variety of other assets, including stock, bonds, mutual funds, real estate, patents or even art.

Cons

• Once the child reaches 18 (or 21), they decide how to spend the money.
• The money is not tax-advantaged.
• The money might serve to disqualify the individual from financial aid.

Summary

Both accounts offer different benefits.  But overall, 529 plans are a great option if you’re looking to exclusively fund educational expenses.  UMTA accounts, on the other hand, allow you to transfer wealth with much more flexibility. 

Of course, there are more regulations and details to follow, so once you decide on which instrument to use, be sure to consult your tax advisor. As always, we are here to help and you can book an appointment with us anytime. 

Disclosure: Emerald Advisors, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

[i] https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html

[ii] https://finaid.org/savings/ugma/

[iii] https://www.putnamwealthmanagement.com/a-529-college-savings-plan-can-be-flexible-as-situations-change#