UTMA vs 529: Which plan should I choose?
You may be considering saving for your child or grandchild’s future educational needs. You could use an UTMA (Uniform Transfer to Minors Act) or 529 Plan to save money for a minor beneficiary. Opening either account allows you to invest contribution funds. However, while the two savings vehicles are often discussed together, UTMAs and 529 Plans function differently and offer different benefits. One may be better suited to help meet your goals and needs. To ensure you make the best decision for you and your family, let’s review how UTMAs and 529 Plans work and what each offers.
UTMA Accounts
UTMAs allow you to transfer many types of assets to a minor beneficiary, and the funds can be used for anything that benefits the minor. It is a form of a custodial account that can hold money, securities, and real estate. You can also invest these contributed assets in a variety of manners.
The custodian manages the UTMA account until the beneficiary comes of age (usually 18 or 21, depending on the state). Until that time, the custodian can invest the assets and spend the assets as they see fit. As I said above, the custodian is responsible for using these assets in a way that benefits the minor beneficiary.
Some individuals choose to open an UTMA in lieu of a trust. UTMAs can pass along an inheritance; however, you cannot set preconditions for the minor to receive the assets from the UTMA.
An UTMA can be appealing because the designated minor can eventually spend the funds on anything. Unlike a 529 Plan, UTMA funds do not need to be used for educational expenses. However, UTMA accounts can impact how much financial aid the beneficiary receives when applying to college. For the purposes of the federal financial aid form (FAFSA), UTMA assets belong to the designated beneficiary. You should thus know that it is more challenging for the beneficiary to get need-based financial aid when the assets are their own. As we will discuss below, 529 Plans can be more advantageous for the beneficiary if they need to qualify for financial aid.
Additionally, UTMA accounts do not have as many tax advantages as a 529 Plan. Unearned income (dividends, capital gains, and interest) above $2,200 is subject to the parent or grandparent’s marginal tax rate.
In total, UTMAs offer the holder and the beneficiary more flexibility in what they invest, how they invest, and how they eventually use the invested funds. This flexibility comes at the cost of less advantageous financial aid and tax treatment compared to a 529 Plan. However, with the added flexibility, UTMAs may be appropriate for individuals who are not yet sure how their beneficiary will need to use these funds.
529 Plans
A 529 Plan is a savings account designed to be spent on educational expenses. You can select a prepaid tuition 529 plan, which can be used to pay for credits at an eligible educational institution. Or you can choose the more popular education savings 529 plan. 529 education savings plans can only be funded with cash and often have limits on how the funds can be invested. Usually, 529 plan funds can only be invested in more conservative securities, such as mutual funds or ETFs. These funds then grow tax-free until they are used to fund the beneficiary’s education.
Unlike an UTMA, 529 Plan funds are considered part of the parent’s wealth when the beneficiary applies for financial aid. This difference makes 529 Plans more advantageous if the beneficiary needs financial support in funding their college education. However, withdrawals from a grandparent’s 529 plan could impact a child’s income when applying for FAFSA.
Additionally, 529 plan earnings and withdrawals are not subject to federal income tax. In some states, you can also claim a state income tax deduction for contributions. For example, Georgia offers the Path2College 529 Plan. Those filing a single return can deduct up to $4,000 in contributions to this plan per beneficiary per year. Those filing a joint return can deduction up to $8,000 in contributions to this plan per beneficiary per year.
529 Plans are always held and managed by the person who opened the account. Management never passes to the beneficiary as it does with an UTMA. Once the manager is ready to start paying for the beneficiary’s educational expenses, the manager can withdraw up to $10,000 per beneficiary per year without paying taxes on the withdrawals. These withdrawals must be used for qualified educational expenses. Notably, if a child has more than one 529 Plan from multiple parents or grandparents, you need to be strategic about when and who withdraws funds. If the total withdrawals go above the beneficiary’s qualified expenses, one of the parents or grandparents could end up with a non-qualified withdrawal and face tax consequences.
Due to the requirement that 529 Plan funds be used for qualified educational expenses, owners of 529 Plans face the risk of their child or grandchild not needing all of the funds in the 529 Plan account for their education. If you end up with extra 529 Plan funds, you have the option of changing the beneficiary of the plan to another family member. For example, a grandparent could transfer the 529 Plan to another grandchild. A parent could also make themselves the beneficiary of a 529 Plan and use the funds to pay off student loans or pay for other qualified educational expenses. Additionally, beginning in 2024, 529 Plan funds can be rolled over tax-free to a Roth IRA in the name of the 529 Plan beneficiary.
Finally, many states have caps on how large a 529 Plan can become. States usually determine how much a student would need for educational expenses and cap the 529 Plan at that amount. Once the 529 Plan reaches the cap, no more contributions can be added until the plan’s total value falls below the cap. For Georgia’s Path2College 529 Plan, the account balance cannot exceed $235,000. This limit applies to all accounts opened for the beneficiary. Once the accounts reach the maximum balance, you may still accrue earnings even though you cannot add contributions.
In conclusion, 529 Plans offer less flexibility but more tax and financial aid advantages. A 529 Plan may be best for you if you’re confident the funds will be used for educational expenses.
Contribution Limits
Contributions to both UTMAs and 529 Plans count as gifts for tax purposes. In 2023, you can thus contribute up to $17,000 per individual per year and qualify for the gift tax exclusion. Any amount above the $17,000 exclusion counts against your lifetime estate and gift tax exemption of $12.92 million. You must report gifts above $17,000 on Form 709 when you file taxes. You can also contribute up to $85,000 per individual per year using a 5-year election rule. The 5-year election rule allows you to make 5 year’s worth of contributions in one year. For example, you could report a contribution of $50,000 on Form 709, and for tax purposes, that $50,000 contribution will be treated as a $10,000 annual contribution over a 5-year period.
What plan should I choose?
There are many intricacies to choosing an UTMA vs a 529 Plan. However, the main question you should ask yourself is: What will the funds be used for? If you are confident the funds will be used for college expenses, a 529 Plan could make the most sense. If you are unsure or you know the funds will be used in another manner, an UTMA may make more sense. Knowing your family’s individual needs and circumstances will also impact your decision. I encourage you to reach out and set up an appointment. We can decide which plan makes the most sense for your family and your needs.
