Should You Use a 529 Plan or an UTMA to Save for College?

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Next to buying a home, paying for college is probably the biggest expense a family will ever have.

And with the average cost of a four-year college between $22,000 and $31,000, parents need to start saving for their children’s education as soon as possible.

A 529 plan is one way to do this. The plan has tax advantages and incentives that make it one of the most attractive options for college savings. However, before 529s emerged in the mid-1990s, many families relied on an UTMA account to save for their children’s education. UTMA, which stands for Uniform Transfers to Minors Act, allows parents to set up a custodial account that they can then transfer to their child once he or she reaches a certain age. However, an UTMA account does not have to be used for education expenses. It differs from a 529 in other ways, as well.

So, which one should you choose to help save for college? If you have young children and want to begin saving for college, here’s what you should know about 529 plans and UTMA accounts.

529 Plans Offer Tax Advantages for Educational Expenses

529 plans grow tax free. If the funds are used properly for education expenses, the withdrawals are tax free (if not, they are subject to a 10-percent penalty and federal income tax). However, UTMAs have very low amounts that are exempt from taxes — typically the first $950 of income. This means that even if your child uses the money in this account for his or her education, these funds and subsequent dividends and interest will be subject to income tax.

UTMAs Have Restrictions on Who Controls the Assets

529 plans give the owner (typically a parent) full control of the assets in the plan. UTMAs have to transfer ownership and control to the child at age 18. This transfer of ownership is permanent, so parents cannot resume control of the account or transfer it to another sibling, for example, if the beneficiary decides to use the funds for personal rather than educational expenses. However, 529s allow the owner to switch the beneficiaries. If one child finishes school early or drops out, the funds can be used for another child.

529s Are Better for the Financial Aid Process

The ownership and income tax components of an UTMA also create issues when applying for financial aid. The income from the assets in the UTMA are considered your child’s assets and count toward income limits in the determination of financial aid. With a 529, the funds are counted as the asset of the parent if the parent or dependent student owns the account. This has a lower impact on financial aid eligibility compared to an UTMA. If you have an UTMA and plan to apply for college financial aid, you can close the account and transfer the funds into a custodial 529 plan. However, if you do this, you won’t be allowed to change the account’s beneficiary and your child will become the account owner once he or she reaches the designated age.

Higher education is a huge expense, so you must be strategic about how you approach it. Bottom line: If you’re saving for the sole purpose of college expenses, then 529s blow UTMAs out of the water. They offer more flexibility, control over the account and tax advantages compared to an UTMA. Plus, they have a lower impact on financial aid eligibility, which is critical for families who need additional help to offset college costs.

If you’d like more details on either of these savings plans, ICCF’s consultants are here to help. Contact us today for more information.

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