Investing In Your Child’s Future
Navigating the Choices Between 529 Plans and UTMA Accounts
When planning for a child’s educational expenses, it is important to understand the various savings vehicles available. Two common options are the 529 Plan and the Uniform Transfers to Minors Act (UTMA) account. Below is an outline that delineates the key differences between them:
Purpose and Use of Funds
- 529 Plan: Specifically designed to fund qualified higher education expenses, including tuition, room and board, books, and other related costs. Some plans have expanded to cover K-12 tuition expenses as well.
- UTMA: A custodial account that provides a way to transfer assets to minors without establishing a trust. Funds can be used for any purpose that benefits the minor, not limited to educational expenses.
Tax Advantages
- 529 Plan: Contributions grow tax-deferred, and distributions for qualified education expenses are tax-free at the federal level and often at the state level.
- UTMA: Usually, the first $1,250 of unearned income typically is tax-free, the next $1,250 is taxed at the child’s rate, and unearned income over $2,500 is taxed at the parent’s rate. There is no tax advantage on distributions since they are not limited to education.
Control over Funds
- 529 Plan: The account owner maintains control over the funds, including decisions about investments and distributions, regardless of the beneficiary’s age.
- UTMA: Control of the UTMA account transfers to the beneficiary once they reach the age of majority (varies by state).
Contribution Limits and Gift Tax Implications
- 529 Plan: Contributions can be sizeable without triggering gift taxes, up to $18,000 per year per donor ($36,000 for married couples electing to split gifts) under annual gift tax exclusion amounts for 2024. There is also an option for five-year front-loading, in which 5 years of contributions are made at once, for a total of $90,000 in contributions per person, per beneficiary.
- UTMA: Subject to the same annual gift tax exclusion, but there is no option for five-year front-loading.
Financial Aid Considerations
- 529 Plan: Accounted for as a parental asset if the parent owns the account, which has a lower impact on financial aid eligibility.
- UTMA: Considered the student’s asset and has a greater potential to reduce financial aid eligibility.
Investment Options and Changes
- 529 Plan: Typically offers a range of investment portfolios with some restrictions on how often the account owner can change investments.
- UTMA: Offers more flexibility in investment choices, similar to regular brokerage accounts; the custodian can make investment changes at any time.
Impact on Beneficiary’s Future Financial Choices
- 529 Plan: Since the owner controls the account, the beneficiary’s access to funds is limited to the terms set by the plan.
- UTMA: Once the beneficiary gains control, they can use the funds at their discretion, which may not always align with the original intent of the funds.
Estate Planning Implications
- 529 Plan: Generally, not included in the estate of the account owner, thereby potentially offering estate tax benefits.
- UTMA: Funds become the property of the beneficiary and may have implications for their estate.
Revocability
- 529 Plan: Contributions can be withdrawn by the account owner at any time, subject to tax and penalty on earnings if not used for qualified education expenses.
- UTMA: Typically, irrevocable gifts; once a contribution is made, it cannot be taken back by the donor.
Both 529 Plans and UTMA accounts offer unique features suitable for different objectives. A 529 Plan is more education-specific with tax advantages tied to this purpose, while a UTMA provides broader options for the beneficiary at the cost of less favorable financial aid treatment and fewer tax benefits. We encourage all clients to consult with their Bridges Trust Relationship Manager to better understand each option and how it aligns with individual goals and circumstances. Please consult with your tax professionals for questions regarding taxes.
