Putting yourself through college is not cheap. The National Center for Education Statistics reports that the total cost of an undergraduate education in 2016–17 was about $17,237 at a public university, $44,551 at a private nonprofit school, and $25,431 at a private for-profit institution.
Because of this, many parents start putting money down for their children’s college educations when their babies are still in diapers.
The cost of higher education can be covered in a number of ways. The Uniform Gift to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) are two more options for college savings that are often overlooked in favor of 529 plans. The upsides and downsides of each type of account vary.
Find out how these accounts function and what advantages they provide before deciding how to save for your child’s education.
Defined 529 Plan, UGMA, and UTMA
Knowing what each type of account is before looking into the benefits and drawbacks is a good idea.
A 529 plan is a tax-advantaged savings account, so called after IRS Code Section 529. One can use these accounts to put money down for future schooling.
As long as the funds are used for eligible educational costs, both the earnings on the account and any withdrawals are exempt from federal income tax. Certain costs are tax-deductible.
- Tuition and fees are required.
- Books, materials, and tools
- Computers, ancillary equipment, software, and Internet connection are all available.
- Room and board are provided for students enrolled at least half-time.
At first, the funds in a 529 plan could only be used for postsecondary education costs. The government, however, changed its mind about what constituted a legitimate business cost in 2017 and now allows up to $10,000 in yearly K-12 tuition to be deducted.
Accounts for UGMA and UTMA
The majority of jurisdictions do not allow minors to enter into legally binding contracts, making it impossible for them to hold investments. It used to be the case that parents who wanted to give their child money for college had to employ a lawyer to set up a trust.
These exchanges were greatly simplified by the UGMA and UTMA. The Uniform Gift to Minors Act (UGMA) created an easy system by which minors may acquire securities including stocks, bonds, and mutual funds. The Uniform Transfer to Minors Act is similar, except it also permits minors to acquire real estate, fine art, patents, and royalties.
Family members such as parents, grandparents, and others can now create a custodial account in the form of a UGMA or UTMA with a financial institution or brokerage.
To create an account for a minor, the account holder must submit the minor’s name and Social Security number and identify a custodian who will be responsible for the account until the minor turns 18. (typically 18 or 21, depending on the state).
What Are the Differences Between 529 Plans and UGMA or UTMA Accounts?
There are several key distinctions between 529 plans, UGMA and UTMA accounts, and other options for saving for a child’s education.
A 529 plan is a tax-advantaged savings vehicle for college expenses solely. The funds in the account are always available for withdrawal. However, there may be tax ramifications if the money isn’t used on approved educational expenditures.
Withdrawals of your contributions are not subject to taxation, but distributions of profits are subject to your normal income tax rates. In addition, there will be a 10% penalty added to your bill. A UGMA or UTMA, however, allows for more flexible use of its holdings.
When comparing tax-free growth options, a 529 plan stands head and shoulders above a UGMA or UTMA. Money accumulated in a 529 plan grows tax-free, so you won’t have to worry about paying Uncle Sam any time soon.
Earnings in a UGMA or UTMA may be subject to taxation even if the money isn’t withdrawn for a long time. If your child earns $1,050 or less in a year, you don’t have to worry about paying taxes.
After $1,050, the IRS taxes the child’s portion of the income at the child’s tax rate, and taxes the remainder at the rate for trusts and estates, which may be significantly higher than the child’s rate.
Requirements for Tax Filing
Managing tax returns is a common difficulty for parents with UGMA and UTMA accounts. Earnings in a 529 plan are exempt from taxation at both the parent and the student levels.
Any withdrawals made from the account for eligible educational costs are not subject to taxation and need only be reported on your tax return.
There may be some added complexity when dealing with UGMA and UTMA accounts. Most individuals don’t have to worry about submitting tax returns for their children throughout the saving years since these accounts don’t often earn enough interest or dividends to warrant doing so.
With an attached Form 8814 to their Form 1040, parents can declare their child’s income if the account’s profits are more than $1,050 for the year.
Control and ownership of the funds
Another benefit of 529 plans is that they make it more likely that the money will be used for higher education.
The beneficiary’s age is irrelevant in a 529 plan; the account holder always has access to the money. If the intended beneficiary of your college savings account no longer needs or is able to use the funds, you may either designate a new beneficiary or take the money out of the account (and pay taxes on the distribution).
When a minor reaches legal adulthood, he or she becomes the legal owner of any money saved in a UGMA or UTMA. Then they may do what they want with the cash. You can’t change the account’s beneficiary if the youngster no longer needs the money for college expenses.
Contributions and Investment Opportunities
The ability to make contributions whenever you want and choose from a wider variety of investment possibilities are two of the many benefits of UGMA and UTMA accounts. Cash, investments, property, artwork, patents, royalties, and more can all be used to finance UGMA and UTMA accounts. In addition, you have a lot of leeway in how you choose to invest the money in the account.
You can only put money into a 529 plan, and you can only invest in the things that the plan allows. While there is no limit to the amount that may be put into a 529 plan, every dollar you put in counts against your yearly gift tax exclusion.
If you contribute more than $15,000 to a beneficiary’s 529 plan in 2019, you will need to submit a gift tax return. This maximum doubles to $30,000 for a married couple who chooses to divide their donations.
There is, however, one notable exception. Gifts for up to five consecutive years can be made without incurring any gift taxes, according to the Internal Revenue Service. For 2019, that equates to an annual salary of $75,000 for an individual or $150,000 for a couple.
The Effect on Student Aid Eligibility
Any money a student has in a Coverdell Education Savings Account (ESA) or Coverdell Education Distribution Account (EDA) will count against them if they are applying for financial help. Federal financial aid formulae include 20% of the money in a UGMA or UTMA account as eligible to pay for college, therefore these accounts have a major influence on eligibility calculations.
Funds in a 529 plan are considered parent assets on the Free Application for Federal Student Assistance (FAFSA), thus they have less of an effect on financial aid. The maximum amount of a 529 plan that can be used to pay for college expenses as determined by the FAFSA calculation is $5,60.00.
If you have funds in a UGMA or UTMA and are concerned about how they could affect your eligibility for financial aid, you may choose to transfer those funds into a 529 plan instead.
To figure out how much tax you’ll owe on your capital gains, though, it’s best to see a financial planner or accountant first.
In what type of savings account would you put your child if you wanted to help them get a head start on their financial future? It all depends on what you want to accomplish. A 529 plan provides superior tax benefits if your investments are intended for higher education expenses.
You can put money into a UGMA or UTMA account for a child even if you don’t know what they’ll use the money for yet.