UTMA vs. 529

When saving for children, grandchildren, nieces, nephews, etc… one of the most common questions we are asked is whether to put funds into a UTMA account or 529. Both provide ways for parents and others to help save for the next generation, but how do you decide which is best? Here are some of the key differences:

Legal/Ownership Structure

UTMAs are taxable accounts where the ownership is tied to the minor and the adult acts as a custodian. Once the minor reaches the age of majority (21 in the state of IL), the account registration transfers from a UTMA to an Individual Account in the minor’s (now legal adult) name. From there, the control of the funds are at the discretion of the “minor.”

529s are tax advantaged accounts where the ownership is tied to the adult, and the minor is a beneficiary of the account. There is no legal ownership back to the minor, even though they may benefit from the account. The owner will retain control of the funds no matter how old the beneficiary becomes and can even change beneficiaries at any time.

One important point to mention is because the assets in the UTMA are owned by the minor, when it comes time to fill out a FAFSA or CSS profile for college, there is going to be an impact on the child’s financial strength because the UTMA is under their ownership. A 529 will not have as significant of an impact on the child’s financial strength from a FAFSA/CSS standpoint.

Contributions and Investment Options

UTMAs can be funded with cash, stocks, bonds, ETFs, and other marketable assets. Gifts to minors fall under the current gift tax rules. For 2021, an individual can gift $15,000 to any individual gift tax free. If you contribute over the $15,000 a gift tax return will need to be completed.

529s on the other hand can only be funded with cash. Contributions are limited to the $15,000 annual limit with one exception; with 529s you have the ability to gift up to 5 years of contributions at one time, or $75,000, without triggering a gift tax. Note that if you choose this method, you cannot make a gift to the beneficiary for a 5-year period. In addition, if you live in a state that enforces a state income tax, you can pick up a state income tax deduction for your contribution into a 529 provided you use your state sponsored plan.   

In terms of investment options, UTMAs are very flexible. You can invest in almost any type of asset including stocks, bonds, mutual funds, ETFs, hedge funds, real estate, and many more. With 529s, you are limited to the investment offerings for the respective state plan. These state plans normally offer a wide variety of options from index funds, to managed age-based portfolios. 

Tax Treatment

As mentioned above, UTMAs are taxable accounts but have a unique rule called a “kiddie tax” that comes into play. This Kiddie Tax applies to:

• children under age 18 at the end of the tax year,

• children age 19 at the end of the tax year who don't provide more than half their own support with earned income, and

• children under age 24 at the end of the tax year who are full-time students and whose earned income does not exceed half of the annual expenses for their support.

The Kiddie Tax states that the first $1,100 of unearned taxable income/gains are taxed at a 0% rate. From $1,100- $2,200, the rate is bumped up to the minor’s marginal tax rate. Any income above $2,200 is taxed at the parent’s marginal tax rate.

With 529s there are two tax advantages. First, the funds grow on a tax-deferred basis. Second, if the funds are used for qualified educational expenses, the gains in the account come out tax free. This is what makes 529 accounts a great savings tool for education. As a note, if you use the funds for something other than a qualified educational expense, not only are the gains taxable, but there is a 10% penalty added as well.

Conclusion

Both UTMAs and 529s are great ways to save for the next generation. When it comes to choosing which account to open, it depends on your desired use for the funds. If you only want to pay for educational expenses, then a 529 offers more tax advantages and may be the better choice. If your desire is to save for your kids and allow them to choose how they spend it (down payment on a home, car, trips, etc.), then the UTMA will offer more flexibility without potential penalties. If you have questions on which account is best for your circumstances, don’t hesitate to reach out to your CCP advisor.