by Melissa Brock
When you’re rushing kids to soccer practice, shoveling Easy Mac like it’s a lifeline (because it is!) and holding down your regular full-time job, who has time to research college plans?
And when you Google “UTMA” and “529 plans,” most information online makes you want to crack back the driver’s seat and sleep through soccer practice.
Let’s make this more entertaining, shall we?
September is College Savings Month, and in the interest of education, UTMAs vs. 529 plans is a super-appropriate topic. Let’s dive in.
What’s a UTMA?
UTMA: Sounds like a new government mandate or raging infection, doesn’t it? (Do you think if it was called the Unicorn Twinkle Marshmallow Act, it would get more attention — especially among kids?)
At any rate, the Uniform Transfers to Minors Act (UTMA) lets gift-givers transfer money to a minor child from a guardian or trustee.
Let’s say you want to open a UTMA account for your five-year-old daughter, Kiki. You put $30,000 in a UTMA account for her. You continue to add money to the custodial account over time — and others can add, too.
When Kiki reaches a specific age (determined by your state, usually between 18 and 25), the custodianship terminates and Kiki gets the money.
Once Kiki owns the account, it’s no longer a UTMA — it becomes a taxable brokerage account. The rules for a taxable brokerage account automatically apply.
UTMAs are generally better savings options for lower balance accounts, and here’s why:
- The first $1,050 of Kiki’s unearned income (interest, dividends or capital gains) is exempt from federal income tax because Kiki is under age 18 at the end of the tax year.
- The second $1,050 of unearned income is taxed at the child’s rate.
- Any unearned income over $2,100 is taxed at the higher of the child’s or parents’ marginal tax rates.
- You can contribute as much as you want, but amounts above $15,000 per year ($30,000 for a married couple filing jointly) incur federal gift tax.
It’s important to note that all assets represent irrevocable transfers. This means that you, as a custodian, cannot take back the money if you later realize Kiki’s not a good money manager.
Pros: UTMAs offer flexibility because your child can use it for anything (but that can also be a con — your child can buy a Porsche with your savings!) However, it’s a good move if you don’t think little Kiki will go to college. UTMAs also offer tax advantages and there are no penalties for early withdrawal. They’re also easy to set up.
Cons: You don’t own the account — your beneficiary does. You can’t use the funds for anyone other than your initial beneficiary, and you can’t transfer the account to yourself or to another child.
How to Set Up a UTMA
Setting up a UTMA account doesn’t take a lot of time. Here’s what it could look like:
- Log into a brokerage account or talk to a financial advisor.
- Set up an account. You may need to fill out some forms, including a fiduciary account application, and show your photo identification, such as a driver’s license, state ID card or passport.
- Transfer funds.
- Dust off your hands.
You, the donor, may be the custodian of the account, but the custodian can also be another adult or a financial institution.
What is a 529 Plan?
- Prepaid tuition plans let you purchase units or credits at participating colleges or universities to pay for tuition in the future.
- Education savings plans allow you to open an investment account to save for qualified higher education expenses. You can also use an education savings plan to save for tuition for elementary or secondary public, private or religious schools. UNest offers this type of plan.
You get to choose which types of investments you want once you open your 529 account. How do you know which investment option to choose? Let’s take a look at the two primary investment options — age-based portfolios and static portfolios.
Age-based portfolios automatically move toward less risky investments as your child gets older. This is a great option if you don’t want to think about managing your child’s investments or if you prefer a set-it-and-forget-it approach. In other words, you leave the 529 plan manager in charge.
The investments in a static portfolio remain the same as your child gets older. This investment type is best if you’re a savvy investor or if you have a specific strategy in mind.
You can invest in target risk portfolios and individual portfolios:
- Target risk investments adjust regularly to meet a specific target.
- Individual portfolios mirror the underlying investments — usually either open-ended or exchange-traded mutual funds. This is a great option if you want to really customize your investments.
Pros: You’ll experience tax advantages — even for larger amounts. They can go to other family members (meaning they’re easily transferable) and choosing investments is easy. Finally, the money in the account won’t be lost if your child doesn’t attend college.
Cons: You’ll encounter somewhat less flexibility with a 529 plan, because it must be used for educational purposes.
How to Choose Between a UTMA or a 529 Plan?
How do you know whether a UTMA or a 529 plan is right for you?
Like anything else, you weigh the pros and cons. Make a list of what works best for your needs. Think through questions like “Am I okay with my child not using the money for college?” and “Do I prefer to transfer money to a sibling if Kiki doesn’t go to college?”
How to Plan for College Expenses
You’ll want to plan carefully for college expenses whether you opt for a 529 or a UTMA. Take action with just a few steps.
Step 1: Start as soon as you can.
One of the greatest benefits of investing in either a 529 plan or UTMA is to start as early as possible. Investing early in either a 529 plan or UTMA means your money has more time to grow and compound. Simple interest refers to interest on principal only. Compound interest involves the interest on the principal as well as any other accrued interest.
Here’s an example of simple interest: Let’s say you originally invest $10,000. The interest rate is 5%. Each year, your original investment will earn $500. Over five years, the account adds $2,500.
Example of 5% compound interest on $10,000:
- First year: $500 in interest
- Second year starting amount (includes the interest from the first year added to the original contribution): $10,500. With 5% interest, the total interest in the second year would be $525.
- Third year starting amount: $11,025, which could grow an additional $551.25 assuming 5% interest.
- Fourth year starting amount: $11,576.25 — could grow by $578.81, assuming 5% interest.
- Fifth year starting amount: $12,155.06. Assuming 5% interest, the account could grow by $607.76 — totaling $12,762.82.
Isn’t that amazing?
Step 2: Get registered!
Get registered with a UTMA through an online brokerage account or a financial advisor.
On the other hand, It’s easy to register for a 529 plan with UNest. Download the UNest app on your phone. You can open your account in less than five minutes. The UNest app registration is simple and intuitive — even if you’ve never invested before.
Step 3: Learn about your investment options.
You can fund UTMAs with any combination of cash and investments. You can buy stocks, bonds, a savings account, mutual funds and real assets, like property, art, patents and cars — and put them into a UTMA account.
529 plans, on the other hand, only allow you to contribute cash. UNest offers a wide variety of investment options to meet your needs, whether you’re a risk-tolerant individual or aren’t super comfortable with market fluctuations.
Step 4: Establish a monthly contribution plan.
How much do you want to contribute? It’s always a great idea to contribute to your child’s college savings account early — and often. UNest’s simple college savings calculator can help you establish your future goal and choose a monthly amount that’s right for you. It’s easy to start with a lower amount, then increase over time. You can start with as little as $25/month with UNest.
Step 5: Keep track of your investments.
Don’t invest and then forget about it till your child’s buying stuff for her dorm. How are those investments growing? Are you putting enough money away? Not enough?
Monitoring your investments can help you figure out whether you’re doing everything you need to do to save for college.
Get Started Now
Don’t agonize about which avenue to take. Ultimately, it’s best to just get started. You can always change your strategy down the road. For example, let’s say you choose a 529 plan but it becomes clear that Kiki’s sister will for sure go to college. You can always switch beneficiaries.
Bottom line: Don’t feel as if you’re locked into a specific investment — or even company. You’ll encounter more flexibility than you think!.
September is College Savings Month, so get caught up in the momentum and start saving!