UTMA and 529 are two solutions available for parents who want to save money for their child’s future college tuition. Both of these are great ways to save money for a minor beneficiary. Many people consider both accounts as substitutes for one another but that’s not right. These are two distinctly different accounts.

The UTMA and 529 have a few similarities between them in that both are types of accounts set up by parents for their minor children. However, they both work differently and they have significantly different benefits.

Neither one is better than the other for every family. Either one may be better suited for you depending on your needs and financial circumstances. Understanding how they work and the pros and cons of each will help you determine which one will work best for you.

UTMA Vs 529: Type Of Account

UTMA stands for Uniform Transfer to Minors Act. It is a type of custodial account that’s opened on behalf of a minor. An adult, which could be a parent or a family member, opens and contributes to this account as a way to allow the minor beneficiary to hold assets. The assets in the account can be used for any purpose on behalf of the minor provided that it is being used for the minor’s benefit.

A 529 plan is a type of education savings account. An adult, mostly a parent, grandparent or adult relative contributes and invests money in this account to be used towards the minor beneficiary’s future educational expenses. Unlike the UTMA, the funds cannot be used for any purpose. It is intended to specifically pay for education-related expenses and can only be used for this purpose.

UTMA Vs 529 – Types Of Assets That Can Be Held In The Account

UTMA accounts can hold a wide range of assets including money, real estate, and securities such as stocks and bonds. The investment options with UTMA are generally flexible.

529 accounts can hold only cash contributions. They cannot hold any other assets. In addition, these accounts also have contribution limits per beneficiary across all accounts. Contribution limits vary from one state to another. The investment options too are limited with a 529 plan. Only conservative securities such as mutual funds and exchange-traded funds (ETFs) are allowed as investments with this plan.

How They Work

An UTMA account acts as a type of trust fund that allows a parent or other adult to pass along an inheritance to a minor. The parent or another adult acts as the custodian to the account and manages it for the minor beneficiary until they come of age – this could be 18 or 21 years, depending on the state of residence. The custodian can invest the money or spend it at their discretion on anything that directly benefits the beneficiary. After the account holder comes of age, they become sole custodians of the account and can manage the assets anyway they want.

A 529 account acts as an investment fund that allows a parent or other adult to grow investments tax-free till the minor beneficiary comes of age. When the minor account holder comes of age at 18 or 21 years depending on the state of residence, the account transfers solely into their name. The funds in a 529 account can be used for the designated beneficiary’s educational expenses. This includes college tuition, fees, room and board as well as elementary or secondary school tuition.

There are two types of 529 plans – an education savings plan and a prepaid tuition plan. The education savings plan lets you contribute and invest towards future educational expenses. The prepaid tuition plan pays for credits at an eligible educational institution.

Account Ownership

An UTMA is a custodial account that’s opened on behalf of a minor. The account itself legally belongs to the account holder – in this case the minor. It is only being managed by the adult custodian until such time that the minor beneficiary comes of age. The beneficiary has control over how the funds in the UTMA are used. Once the minor account holder comes of age, the account automatically becomes a taxable brokerage account in their name.

A 529 savings plan does not belong to the minor beneficiary. It technically belongs to the person who opened the account. At any time, the person who opens the account can transfer funds from a 529 plan to an immediate family member other than the beneficiary in whose name the account was originally opened.

Ability To Change Beneficiary

With an UTMA account, there’s zero flexibility with regards to changing the beneficiary. The minor beneficiary gets full control of the funds after they turn the age of majority and can spend it anyway they want. This is regardless of whether or not the parent or custodian determines that the account holder is not ready to handle their finances responsibly. The funds cannot be transferred to another beneficiary under any circumstances.

A 529 plan offers more flexibility with regards to changing the beneficiary. With a 529 plan, the person who opens the account can change the beneficiary any time. For example, if a parent determines that their child is not ready to handle the assets in the account, they can transfer the account to another beneficiary.

Qualified Expenses

Although the assets in an UTMA account are intended for education-related expenses, they can be used for any other purpose that benefits the designated beneficiary. The account transfers automatically to the minor account holder on their 18th (or 21st) birthday. If the account holder gets a college scholarship or decides not to go to college, they can choose to use the UTMA assets for any other purpose.

The 529 plan is more rigid in terms of how the funds can be used. With this type of account, the funds can only be used for education-related expenses. A penalty will apply if the funds are used for any other non-educational expenses. If the account holder gets a college scholarship or decides not to go to college, they cannot use the funds for any other purpose. Instead, the account holder who opened the account can transfer the funds to another beneficiary for their education expenses.

Tax Implications

With an UTMA account, the first $2,100 in unearned income may be tax-free. Unearned income includes capital gains, dividends, and interest on contributions to the account. Anything over $2,100 is subject to tax rate for trusts and estates, which is often referred to as the “˜kiddie tax’. While there are no contribution limits for an UTMA account, a transfer of over $15,000 to a single recipient in a given year may attract gift tax. Ultimately the tax burden on an UTMA account is higher than that of a 529 account.

529 plans are more tax-friendly. Earnings and withdrawals into and out of these accounts are not subject to federal income tax. Some states too do not impose a state income tax. In addition, depending on your state of residence, you may even be able to claim a state income tax deduction on your contributions. There are no provisions for federal income tax deductions for 529 plans.)

Financial Aid Impact

UTMA accounts have a bigger impact on financial aid. All assets in the account have to be listed as the beneficiary’s assets on the FAFSA form. This makes it more difficult for the student to qualify for financial aid as they already have substantial assets in the UTMA account.

529 accounts have a smaller impact on the beneficiary’s ability to qualify for financial aid. Assets in a 529 account are listed as the parent’s assets on the FAFSA form. As the beneficiary has fewer assets, they qualify for more financial aid in the form of grants, work-study, and low-cost federal student loans.

UTMA Vs 529: Which One Should You Choose?

It’s no easy decision, UTMA vs 529. Both plans has their own distinct features as well as different pros and cons. In making this choice, the decision often comes down to weighing the flexibility of an UTMA account with the potential tax advantages of a 529 plan.

Reasons to open an UTMA custodial account:

  • Contributing cash, stocks, or bonds or even a house or car into the account
  • You want your child to get full control of their investment account when they come of age
  • You want the funds to belong to the account holder, regardless of other circumstances
  • Flexibility of being able to spend the money for other purposes instead of being limited to higher education only
  • You understand the tax-disadvantages

Reasons to open a 529 account:

  • You prefer to be the owner of your child’s account
  • You plan to contribute only cash into the account
  • Ability to transfer the funds to another immediate family member
  • You want the funds to be used only for higher education expenses
  • You stand to save much more with the tax benefits of a 529 plan

When deciding UTMA vs 529 account for your child, don’t get stuck in decision mode. In the end, both accounts allow you to save money for your child’s future education. Whichever account you decide to open, your minor child will benefit when they come of age.