UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) accounts allow the transfer of financial assets to a minor without establishing a trust. (UTMA and UGMA accounts are basically the same, with UTMA accounts allowing for the inclusion of additional asset types, like real estate. Most states replaced their UGMA statutes with UTMA statutes, but a few states still only allow UGMA accounts.)
529 plans are education savings plans with tax and financial aid benefits that are sponsored by individual states and the District of Columbia. A person can use any state’s plan, but there may be tax benefits to using the plan offered by one’s own state.
UTMA and UGMA accounts are held in the name of the minor, but controlled by a parent or other relative until the child reaches the age of majority, which varies by state.
529 plans are owned by a parent, grandparent, or other adult, with the child being the beneficiary.
Impact on Financial Aid
UGMA/UTMA accounts are reported as a child’s asset on the FAFSA (Free Application for Federal Student Aid), which reduces financial aid eligibility by 20% of the asset value.
529 plans are usually reported as a parental asset and reduce financial aid eligibility by up to 5.64% of the asset value.
UGMA/UTMA contributions are made with after-tax dollars. The first $1,100 of a child’s unearned income each year is tax-free. The next $1,100 is taxed at the child’s rate. Anything over that is taxed as the parent’s income.
Many states plus the District of Columbia allow 529 deductions from state taxes, but in most states, deductions are allowed only for contributions to the home state’s plan. Seven states allow a deduction even if the taxpayer has contributed to 529 plans in other states: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania. Seven states with a state income tax do not allow deductions for 529 plan contributions: California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina. The remaining states either offer a state income tax deduction or credit, or have no state income tax. The amount of the deduction allowed varies by state. (Note: State laws can change, so be sure to check for the latest tax rule for your state.)
Earnings in a 529 plan are not taxed and funds can be withdrawn tax-free as long as they are used to pay for qualified educational expenses.
Contributions to both custodial accounts and 529 plans are subject to gift tax rules. In 2021, the gift tax exclusion is $15,000, which is the amount that can be gifted per donor per beneficiary. (A married couple counts as two donors.) However, 529 rules allow five years’ worth of gifting in one year, which entails special tax reporting.
Funds in an UGMA/UTMA account can be used for anything that benefits the child, such as clothes for school and summer programs.
To avoid income taxes and other penalties, funds in a 529 plan must be used for specific educational expenses, including tuition, fees, books, supplies, room and board, and a computer. Also, 529 funds can be used to repay the beneficiary’s student loans up to a lifetime limit of $10,000. An additional $10,000 can be used to repay student loans held by each of the beneficiary’s siblings. Funds in 529 plans can also be used to pay for private school tuition for kindergarten through 12th grade, but there is a limit of $10,000 per year. Any other 529 withdrawals are subject to income taxes and other penalties.
Note: Saving money in a custodial account in addition to a 529 plan could help when it comes to paying for non-qualified expenses, such as application and testing fees, transportation costs during college, health insurance, medical bills and other miscellaneous expenses.
Funds in an UTMA account can be invested in anything.
Each state’s 529 plan offers its own menu of investment choices, which generally include age-based portfolios, which have a pre-set combination of mutual funds, and individual portfolios, which allow the account owner to design a portfolio from a variety of funds. Fund expenses vary from state to state. You can also research the plans available in your State.
West Branch Capital offers investment management of both custodial accounts and 529 plans. Give us a call or send us a message if you have any questions.