UTMA vs 529: Which one should I choose?

Only one is designed as a college savings plan.

Elissa

Elissa Suh

Published December 4, 2019

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KEY TAKEAWAYS

  • UTMA accounts are custodial accounts, but the money in them has to be used on behalf of the child beneficiary

  • A 529 plan is an education savings account specifically intended to pay for expenses like college tuition and textbooks

  • Both UTMA accounts and 529 plans can affect a child’s financial aid eligibility

If you’re a parent trying to save money for your child’s future college costs, you might have considered an UTMA account or 529 plan. These are two distinct ways to save money on behalf of a minor beneficiary. When you open an UTMA account or 529 plan, you can invest the money that you contribute to it.

An UTMA account provides a way to transfer a wide variety of assets to a minor beneficiary. The funds can be spent on anything that benefits the minor. A 529 plan is a savings account that is specifically intended to help pay for educational expenses.

These two savings vehicles are often talked about together or as substitutes for each other. While they share some similarities, like tax advantages, they have different benefits. One may be better suited to your needs than the other. We’ll discuss how they work and how each one might help you pay for college.

In this article:

UTMA account

An UTMA account is a type of custodial account. An adult, like a parent or family member, opens a custodial account on behalf of a minor to allow them to hold assets. UTMA accounts can hold many types of assets, including money, securities like stocks and bonds, and real estate, and the investment options are usually flexible.

Until the minor comes of age (usually 18 or 21, depending on the state) and gains ownership of the UTMA account, it will be managed by a custodian. The custodian can invest the money or spend it at their discretion for the minor’s benefit.

UTMA accounts can be opened as an alternative to a trust to pass along an inheritance to a minor. However, unlike a trust, you can’t set any preconditions for the minor to receive the assets.

Learn more about how UTMA accounts work.

529 plan

There are two types of 529 plans: a prepaid tuition plan that helps pay for credits at an eligible educational institution, and an education savings plan. The latter is the more common plan that is usually compared to an UTMA account. This 529 savings plan lets you contribute and invest money for a beneficiary’s future educational expenses.

529 plans can only be funded with cash contributions and the investment options are often limited to more conservative securities, like mutual funds and ETFs. The investment grows tax-free and the account holder can spend it for the designated beneficiary's education, which not only includes college expenses like tuition, fees, and room and board, but also elementary or secondary school tuition.

529 plans have contribution limits per beneficiary across all accounts, which vary by state.

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Which should you choose?

When you’re trying to decide between an UTMA account and a 529 plan it is important to consider what you want to use the money for. Do you have an intended purpose for the savings? A 529 savings plan is most beneficial when it’s used for educational expenses; you may even have to pay a penalty if you use the money in the account for something else. On the other hand, the designated beneficiary of an UTMA account can spend the money on anything — even something other than college tuition.

Other things to consider when comparing an UTMA vs 529 plan:

Financial aid

When a child applies for higher education they may be eligible for federal financial aid. Both the UTMA and 529 plan will affect someone’s ability to get need-based financial aid in different ways.

Any UTMA account assets are counted as the designated beneficiary's, while the 529 plan assets are counted as the parent’s on the FAFSA form. It is harder for a child to qualify when the assets are theirs, so UTMA accounts are less advantageous than 529 plans when it comes to qualifying for financial aid.

If you aren’t able to receive financial aid because of an UTMA account or 529 plan, you may need to take out a student loan.

Taxes

529 plans offer robust tax advantages, since the earnings and withdrawals are not subject to federal income tax or even sometimes state tax. Additionally, depending on your state, you may be able to claim a state income tax deduction for contributions. (There are no federal income tax deductions for 529 plans.)

For UTMA accounts, the first $2,100 in unearned income (dividends, capital gains, and interest on your contributions) may be tax-free, but anything over that amount is subject to the tax rate for estates and trusts. This is sometimes called the "kiddie tax," and because of it the UTMA's tax benefits may be limited.

Keep in mind that there are no contribution limits for UTMA accounts. However, the gift tax may come into play when anyone gives over $15,000 to a single recipient in a given year.

If you have concerns about financial aid, investment objectives, or tax concerns, you might consult with a financial advisor or tax accountant to learn more about what's best for your situation.

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