Yahoo Finance 3 Big Differences Between 529 College Savings Plans, UTMA Accounts
College is expensive. According to the College Board, the average cost for a year of college is $22,958 for out-of-state residents attending a public university, and the tuition jumps to $31,231 for private schools.
That's a lot of cash for parents to save, so it's no wonder that lots of moms and dads are looking for ways to maximize growth potential while minimizing associated costs like taxes and fees.
For those reasons, 529 plans are one of the most popular vehicles for college savings, as they allow for tax-free growth and withdrawals, as long as the funds are used for approved educational expenses.
But before the advent of 529s in 1996, parents looked to the Uniform Transfers to Minors Act of 1986, which allows large gifts -- including money for college expenses -- to be made to minors, while still qualifying for gift tax exclusion.
When considering the best method to save for college, parents may consider both 529s and UTMA accounts. And in that case, it's important to examine the biggest differences between the two.
[Learn how to minimize four potential drawbacks of 529 plans.]
1. Who controls the account: Parents who contribute large sums to college savings accounts will likely expect those funds to actually be used for college, and with 529 accounts, that is all but guaranteed. If the funds are used for anything other than qualified educational expenses, the earnings withdrawn from the account are hit with a 10 percent penalty, and withdrawals are also subject to federal income tax.
In the event that the initial beneficiary no longer needs the funds for college, parents are able to transfer the accounts to another, related beneficiary, such as a sibling.
With UTMAs, controlling the use of the funds is significantly more difficult. A UTMA account is designed to pass a large sum of money, real estate or other inheritance to a minor, and once the child reaches adulthood at age 18 or 21, depending on the state, the control of the account is completely -- and permanently -- transferred.
"The transfer of assets from the donor to the minor in the account is irrevocable," says financial advisor Steven Cliadakis, with Altum Wealth Advisors in San Francisco, California. "The donor cannot transfer the asset back or to a third party."
Parents also cannot dictate how the funds are used once the account is transferred. And unlike 529s, UTMAs have no stipulations on expenditures.
"If your objective in establishing an UTMA account was to use the funds to ensure a finer higher education for your firstborn child, that financial benefit may not be deployed as you wished," Cliadakis says.
[Get answers to four common questions about spending 529 funds.]
2. Income tax requirements: The rules governing 529 accounts work to encourage use of the funds for educational purposes because most beneficiaries will want to avoid income taxes.
But there's no special benefit for spending money from a UTMA account on education. Regardless of how the UTMA beneficiary chooses to spend the funds within the account, they will be subject to income taxes.
"UTMAs are considered assets of the child and the income they produce (including dividends or interest) will be taxed as income to the child," says Joshua Duvall, a certified financial planner with Philadelphia's Cordasco Financial Network. "There is a $2,100 'kiddie tax' threshold, above which all excess earnings are taxed at the parents' highest marginal rate, which is based on parental income. This is extremely disadvantageous for both the child and parents."
[Find out how to get a 529 plan boost from your state.]
3. Impact on financial aid eligibility: After families fill out the FAFSA, the Free Application for Federal Student Aid, parental income is the first factor considered when determining a student's expected family contribution. After that, assets of both the parent and the student and the student's income are examined.
"If you have a high enough income, then assets don't matter because you will not receive aid," says Bill DeShurko, a certified financial planner and founder of 401 Advisor in Centerville, Ohio. "If, however, you are a single income family or have multiple children in college at the same time, financial aid may be a planning issue. With a UTMA, the money is considered a child's asset, but with a 529 plan, the balance is considered a parental asset. So the UTMA will be given much higher weight in determining financial aid, making it much more difficult to qualify."
Experts say the biggest benefit of UTMAs is the ability for a parent or grandparent to reduce their estate for tax purposes -- but 529s offer that advantage, too, for those who front-load contributions. Duvall says 529s are mostly run through their respective states, and the investment choices are limited, typically to a few "model portfolios," such as aggressive growth, moderate growth, moderate, moderately conservative and conservative.
Although these include both stock market and fixed income investments, he says, they are not flexible. UTMAs, on the other hand, can be completely open to investments of all different kinds, just like a normal brokerage account or IRA. Duvall says savvy investors may prefer a UTMA because of the greater investment choices it offers.
Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.
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