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A 529 plan or a custodial account, such as an UTMA or UGMA account, are excellent ways to save money for college expenses for a minor beneficiary. All three can be a good fit depending on your situation.
Whether your sole objective is to fund a child’s education—or if you want greater flexibility regarding allowable expenses—is another factor to consider in choosing the right option for contributing to a minor beneficiary’s future. Here is more information about these options to help you decide on the best path.
UTMA is an acronym for the “Uniform Transfer to Minors Act.” An UTMA account is a type of custodial account that any adult can fund for the benefit of a minor beneficiary. The UTMA rules allow a minor beneficiary to receive gifts without the aid of a guardian or trustee. The law replaces and extends the provisions of the Uniform Gift to Minors Act (UGMA).
An UTMA account is usually opened and managed by a parent or family member. Once the minor beneficiary reaches an age designated by their home state (usually their majority but not always), the account comes under their control.
While paying for college is a common reason for an UTMA account, it can be used for a variety of purposes as long as the expenditures are for the benefit of the minor beneficiary. It can also be used to pass assets to a child that will become theirs upon adulthood. A custodial account of any sort can be less expensive and complicated than using a trust to do this.
The UTMA superseded the UGMA in part to expand the range of eligible investment assets. The UGMA limited financial investments to traditional ones, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), and cash, while the UTMA allows investments in what are called “real” or “tangible” assets, such as real estate, collectibles, jewelry, precious metals, oil and gas, and other alternatives.
Additionally, UTMA accounts can accept contributions from estates; UGMA accounts can only accept contributions from living people.
An UGMA account is a type of custodial account that is very similar to an UTMA account. There are two main differences. First, an UGMA account cannot invest in tangible assets. Second, money can only be donated by living persons. In contrast, UTMA accounts allow contributions from estates.
The uses of an UGMA account are identical to those of an UTMA account. Any expenditure that benefits the minor beneficiary is allowed, and the funds eventually come under the control of the beneficiary with no restrictions on their usage.
However, UGMA accounts can no longer be opened, having been superseded by UTMA accounts in all 50 states and the District of Columbia.(South Carolina was the last state to do this, in March 2022.) Existing UGMA accounts can continue to be used and funded until the beneficiary is no longer a minor and takes control of the account at the age designated by their state.
A 529 plan is a tax-advantaged savings account designed to amass funds to pay for the college expenses of the account’s beneficiary. Money is deposited into it on an after-tax basis (though some states allow tax deductions for depositors from the state) and is invested inside of the account. The funds grow tax deferred and can eventually be withdrawn tax free, though only for eligible educational expenses.
A 529 plan can be established by anyone who wants to contribute to the beneficiary’s college savings, though the originator is often a parent or another family member. You can even fund a 529 plan for yourself.
A 529 plan is limited to paying for the higher education expenses of its beneficiary (though it has been recently expanded to include K-12 expenses in some situations). Leftover funds can be transferred to a new beneficiary if they are a family member of the original one. If there is money left in the plan that can’t be spent on education expenses for a beneficiary, withdrawing it may trigger taxes and a possible penalty.
| Characteristics | UTMA plan | UGMA plan | 529 plan |
|---|---|---|---|
Ownership and control | Owned by minor beneficiary but controlled by an adult until the beneficiary reaches a preset age | Owned by minor beneficiary but controlled by an adult until the beneficiary reaches a preset age | Owned and controlled by an adult |
Tax treatment | No tax deduction for contributions; Income can generate taxes for beneficiary and/or custodian | No tax deduction for contributions; Income can generate taxes for beneficiary and/or custodian | No federal tax deduction for contributions (some states may have one); Tax-deferred earnings; Tax-free withdrawals for qualified educational expenses only |
Financial aid impact | Up to 25% reduction of college financial aid | Up to 25% reduction of college financial aid | Possible 5.64% reduction of college financial aid |
Change beneficiary | Not allowed | Not allowed | Can be changed to another family member |
Investment options | Both traditional and real assets | Traditional assets only | Dictated by the plan |
Qualified expenses | Anything spent in service of the beneficiary | Anything spent in service of the beneficiary | Limited to qualified educational expenses as defined by the IRS |
Gift tax | Applies | Applies | Applies |
An UTMA or UGMA custodial account can be the better choice if you want fewer restrictions on how the money can be spent, greater investment flexibility, and don’t care how the money is used once the beneficiary assumes control of the account.
A 529 plan is better if you want to strictly limit the use of the money to paying for education expenses. It’s also better if you think you may want to transfer leftover funds to another beneficiary (you can’t change the beneficiary for UTMA/UGMA accounts). The money in the account also grows tax deferred, which is not the case for UTMA/UGMA accounts.
There are a number of alternatives to UTMAs, UGMAs, and 529 plans. These include:
The best option for your minor beneficiary will vary based on your goals and situation. A 529 plan offers a number of tax advantages and less of an impact on the beneficiary’s eligibility for financial aid. An UTMA account offers greater flexibility in terms of both available investments and eligible expenses. UGMA accounts don’t factor into the equation, as they can no longer be opened.
If your goal is to transfer assets to a minor beneficiary that they can use in adulthood, UTMA accounts and 529 plans are less complex and more economical than a trust, but they feature less future control of the funds.
While you cannot convert an UTMA or UGMA account directly to a 529 plan account, you can withdraw funds from one and then deposit them into a 529 plan for the same beneficiary. The process could trigger taxes on unrealized gains on investments in the UTMA or UGMA account for the minor beneficiary and/or their custodian.
No. Income generated by these accounts can be taxable to the minor beneficiary and/or their custodian. This taxable income could come from interest, dividends, or capital gains.
One is not better than the other. Which you choose depends on your financial goals.
No. However, the annual gift tax exclusion does apply, so you might incur taxes on your contribution. For 2024 the limit is $18,000 per person, while the lifetime gift and estate tax exclusion is $13.61 million per individual.
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