Get educated on future education

Saving for a child’s education is one of the most important financial goals for many parents – and something I have been thinking about a lot more lately. With the rising costs of higher education, it’s crucial to start planning early. Two popular options for education savings are 529 plans and UTMA/UGMA accounts. This article aims to share some of my research & help future (or current) parents understand the key differences between these accounts and decide which one is best suited for their needs.

Overview of 529 Plans

Definition: A 529 plan is a tax-advantaged savings account designed specifically for education expenses. These plans are state-sponsored and can be used to save for college, K-12 tuition, and other educational costs.

Tax Benefits: One of the main advantages of 529 plans is the tax-free growth of investments. Withdrawals are also tax-free when used for qualified educational expenses, which include tuition, fees, books, supplies, and room & board. Additionally, many states (not all) offer tax deductions or credits for contributions to a 529 plan, providing further tax benefits.

Qualified Expenses: Qualified expenses for 529 plans cover a wide range of educational costs, making them highly beneficial for families planning for future education needs. These expenses include not only college tuition but also fees, books, supplies, and room & board. Some plans also cover K-12 tuition and certain apprenticeship programs.

Control and Flexibility: The account owner retains control over the 529 plan and can change the beneficiary to another family member if needed. This flexibility is particularly useful if the original beneficiary decides not to pursue higher education. The ability to change beneficiaries without incurring penalties allows families to adapt to changing educational plans.

Impact on Financial Aid: 529 plans are considered parental assets, which means they have a relatively low impact on financial aid eligibility. This can be a significant advantage when applying for need-based financial aid. The value of a 529 plan is assessed at a maximum rate of 5.64% when determining a family’s expected contribution, compared to 20% for assets held in the child’s name.

Overview of UTMA/UGMA Accounts

Definition: UTMA (Uniform Transfers to Minors Act) and UGMA (Uniform Gifts to Minors Act) accounts are custodial accounts that allow adults to transfer assets to minors. These accounts are managed by a custodian until the child reaches the age of majority, which varies by state but is typically 18 or 21.

Tax Treatment: Earnings in UTMA/UGMA accounts are subject to annual taxes. The first $1,050 in earnings is tax-free, the next $1,050 is taxed at the child’s rate, and any earnings above that are taxed at the custodian’s rate. This tax treatment can be less advantageous compared to the tax-free growth offered by 529 plans.

Flexibility: One of the key benefits of UTMA/UGMA accounts is their flexibility. Funds can be used for any purpose once the child takes control of the account, not just for education. This makes these accounts a good option for families who want to provide financial support for a variety of future needs, such as buying a car, starting a business, or other significant expenses.

Control and Ownership: The custodian manages the account until the child reaches the age of majority, at which point the child gains full control over the funds. This transfer of control can be a disadvantage if the child decides to use the funds for non-educational purposes. Parents should consider whether they are comfortable with the child having unrestricted access to the funds at a relatively young age.

Impact on Financial Aid: UTMA/UGMA accounts are considered the child’s assets, which can significantly reduce financial aid eligibility. This is an important consideration for families relying on financial aid for college expenses. Assets held in the child’s name are assessed at a higher rate (20%) when determining financial aid eligibility, which can reduce the amount of aid the student receives.

Key Differences Between 529 Plans and UTMA/UGMA Accounts

Tax Advantages: 529 plans offer more favorable tax treatment with tax-free growth and withdrawals for qualified educational expenses. In contrast, UTMA/UGMA accounts are subject to annual taxes on earnings. The tax-free growth of 529 plans can result in significant savings over time, especially for long-term investments.

Usage of Funds: 529 plans are restricted to educational expenses, while UTMA/UGMA accounts offer more flexibility in how funds can be used. This flexibility can be beneficial if the child does not pursue higher education or if there are other significant expenses to cover.

Control and Beneficiary Changes: The account owner retains control of a 529 plan and can change the beneficiary, whereas UTMA/UGMA accounts transfer control to the child at the age of majority and do not allow for beneficiary changes. This control can be crucial for parents who want to ensure that the funds are used for their intended purpose.

Financial Aid Impact: 529 plans generally have a smaller impact on financial aid eligibility compared to UTMA/UGMA accounts, which are considered the child’s assets. The lower impact on financial aid can make a significant difference in the amount of aid a student receives.

Considerations for Choosing the Right Account

Educational Goals: If the primary goal is to save for education, a 529 plan is likely the better choice due to its tax advantages and lower impact on financial aid. However, if there is a need for flexibility in how the funds are used, a UTMA/UGMA account might be more suitable. Parents should consider their long-term goals and the likelihood that the funds will be used for education.

Control Preferences: Parents who want to retain control over the funds should consider a 529 plan, as it allows the account owner to manage the account and change the beneficiary if necessary. This control can provide peace of mind that the funds will be used appropriately.

Tax Implications: Evaluate the tax benefits and potential liabilities of each account type. 529 plans offer tax-free growth and withdrawals for education, while UTMA/UGMA accounts are subject to annual taxes on earnings. The tax advantages of 529 plans can result in significant savings over time.

Financial Aid Concerns: Consider how each account type will affect financial aid eligibility. 529 plans have a smaller impact on financial aid compared to UTMA/UGMA accounts. Families relying on financial aid should carefully consider the implications of each account type.

To Conclude

Choosing the right savings plan for your child’s education is a critical decision that can have long-lasting financial implications. Both 529 plans and UTMA/UGMA accounts offer unique benefits and drawbacks, and the best choice depends on your individual circumstances and goals.

529 plans are generally the preferred option for parents who are certain that the funds will be used for educational purposes. The tax-free growth and withdrawals, combined with the ability to change beneficiaries and the lower impact on financial aid eligibility, make 529 plans a highly attractive choice for college savings. Additionally, the control retained by the account owner ensures that the funds are used as intended, providing peace of mind.

On the other hand, UTMA/UGMA accounts offer greater flexibility in how the funds can be used, which can be advantageous if there is uncertainty about the child’s future educational plans. These accounts allow for a wide range of investments and can be used for any purpose once the child reaches the age of majority. However, the annual taxation of earnings and the higher impact on financial aid eligibility are important considerations.

Ultimately, the decision between a 529 plan and a UTMA/UGMA account should be based on your family’s specific needs and financial goals. Consider factors such as your educational objectives, control preferences, tax implications, and financial aid concerns. Consulting with a financial advisor can provide personalized guidance and help you make an informed decision that aligns with your long-term plans.

By starting early and choosing the right savings plan, you can help secure your child’s financial future and provide them with the resources they need to succeed in their educational endeavors. Investing in your child’s education is one of the most valuable gifts you can give, and careful planning today can make a significant difference tomorrow.

.M