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529 vs. UTMA

Dear Clients and Friends,

As the fall weather sets in, leaves begin to turn, and pumpkins and ghosts begin popping up everywhere, we thought that it would be appropriate to write about one of personal finance’s spookiest topics: college costs and how to plan for them. Many readers have probably heard about the 529 plan, America’s college funding darling; however, there are other options, such as the UTMA (Uniform Transfers to Minors Act) or UTMA 529. Today, we will highlight some of the advantages and disadvantages of each, and which circumstances might make each a compelling option.

First, let’s talk about UTMA/UGMA (Uniform Gifts to Minors Act) accounts. Simply speaking, these are investment accounts that a parent or guardian can set up for the benefit of a minor. The money is the property of the minor and must be used for their benefit; however, the guardian retains control of the account’s management. Once the minor comes of age, the money must be handed over to them. This is a great way to introduce your children to the world of investing and the substantial long-term benefits of compounding interest. These types of accounts allow for very flexible investment choices. The first $1,050 of unearned income in an UTMA account is not reported for tax purposes. The next $1,050 is paid at the minor’s tax rate, which is almost always significantly lower than the guardian’s tax rate.

This all sounds great so far, but there are potential drawbacks as well. First, while there are tax benefits regarding the first $2,100 of unearned income, any income exceeding this amount will trigger the “Kiddie Tax” and must be paid at the parent’s marginal tax rate. Second, any gift into an UTMA or UGMA account is irrevocable. This money now belongs to the minor, and it is theirs to do with as they please when they come of age. This is potentially the biggest concern of relying on an UTMA/UGMA account for college funding purposes. Anyone here remember making any stupid decisions when they were 18? Finally, money held in an UTMA or UGMA account would be considered an asset of the student when applying for federal financial aid. A student’s assets weigh almost 4 times more than the assets of their parent or guardian on the FAFSA application, so this could have a serious impact on your child’s expected contribution.

Second, let’s discuss the pros and cons of 529 plans. 529 plans were introduced with the Small Business Job Protection Act of 1996 and have become one of America’s most popular college funding tools. There are multiple tax benefits that come with 529 plans. More than half of states allow for a state tax deduction of funds that are contributed to a 529 plan. Money within a 529 plan grows tax deferred, like your IRA or 401K plan. Finally, withdrawals are taken tax free so long as they are used for qualified educational expenses, including certain non-tuition related expenses such as off-campus housing. Another benefit of the 529 plan is the five-year upfront gift tax exclusion. This allows a married couple to contribute $150,000 into a 529 plan, per beneficiary, and not pay any gift tax. This is a great way to kick-start a college savings plan while moving assets out of your estate into a location where you maintain control. As we mentioned previously, UTMA/UGMA assets are considered student assets on the FAFSA. Assets inside a 529 account are considered parental assets and receive more favorable treatment. Finally, recent regulation allows parents to use 529 assets to pay for up to $10,000 per year in K-12 school expenses.

However, 529 plans aren’t perfect. One drawback is that the funds must be used for qualified higher education expenses. If they aren’t, they may be subject to income taxation and an additional 10% penalty (although there are exceptions). You can change the beneficiary of a 529 plan to virtually anyone in your family, so there are almost always ways to avoid non-qualified withdrawals. 529 plans have severely limited investment options when compared to UTMA accounts. Most plans are limited to what we refer to as age-based “catch-all” funds. These funds are great for a saver who doesn’t want to worry about the daily management of their funds, but this may not be the best fit for an investor who would like more control over their investment options.

Third is the UTMA 529 account - a hybrid of the UTMA account and 529 plan. The funds in this account have all the tax and financial aid benefits of the 529 but are considered an asset of the minor so that they may take control of the assets when they come of age. The funds must still be used for qualified education expenses in order to avoid taxes and a withdrawal penalty, but control would be handed to the minor once they came of age. You may also lose the flexibility to change the beneficiaries in an UTMA 529 account, depending on your state.

Now that we have discussed the basic features of each type of account, it may seem like the 529 plan is always the best option. While it is for many parents whose purpose is to create a fund for higher education expenses, there is a time and a place for the UTMA and UTMA 529 plan as well. Parents who want to be more hands-on with the investments would probably opt for an UTMA account. Minors with a very large UTMA may want to roll a portion into an UTMA 529 plan to avoid the “Kiddie Tax.” At the end of the day, everyone’s situation is different, and everyone’s priorities are different, which is why it is important to be armed with the knowledge to make the best choice for yourself and your family.

We hope that you have found this weekend’s reading interesting and informative. If you would like to discuss the nuances in greater detail, we here at MORWM are always happy to converse and educate.

Happy weekend and happy Spooktober,

-Daniel Levinson


Daniel Levinson Financial Planning Associate

MOR Wealth Management, LLC

1801 Market Street, Suite 2435 Philadelphia, PA 19103 P: 267.930.8303 | c: 856-906-4888 | f: 267.284.4847 |

The majority of this content was written and distributed MOR Wealth Management, all rights reserved. Securities offered through Commonwealth Financial Network, Member FINRA/SIPC. Fixed insurance products and services offered through CES Insurance Agency.


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