Having kids changes your priorities in life. Not only with your time and energy, but also your resources. And as we all know, our resources are finite, making maximization of where we allocate each dollar of our resources crucial if we want to achieve our various goals (all of which are competing for our precious, finite resources I may add).
While there are several savings-accounts for kids available1, today’s post will focus on the 2 most common I encounter: The 529 Plan and the UTMA
1Savings Accounts, CD’s, and Trusts are among other available types of accounts for kids. Roth IRA’s also become an option once the child begins earning income.
What is a 529 Plan?
A 529 Plan is a state-sponsored, tax-advantaged savings plan. While an imperfect analogy, think of it like a Roth 401k Plan in that you pay taxes first on any dollars you want to put in, you select from a pick-list of available Funds within the 529 Plan, and then your money grows tax-free within the 529 Plan and can be withdrawn tax-free, as long as it is used for qualified education expenses – a broad definition encompassing:
• Tuition
• Housing while enrolled at least half-time in school
• Meal Plans on campus
• Textbooks, Supplies, and Computers
• Repayment of Student Loans after school, up to $10,000 per kid
• [In certain states] up to $10,000 per year per kid for K-12 Tuition (Colorado is NOT one of them, for example)
While the above are quite broad for “education expenses”, the most popular objection to 529’s is the uncertainty of a kid going to college, which I respond with these 2 considerations:
1) You can change the Beneficiary of a 529 Plan at any time2. If you have multiple children (or heck, you want to invest in yourself through additional continuing education or a career change), this can often alleviate the fear of being taxed and penalized if 1 of your children doesn’t end up going to college
2) The SECURE 2.0 Act of December 2022 enacted a new law allowing for up to $35,000 per beneficiary to be rolled from a 529 to a Roth IRA. This law is extremely complicated (you’ve been warned), but still alleviates some fear of ‘over-funding’ a 529 Plan
2Certain 529 Plans also allow the Owner of the 529 Plan to be changed, which can be done to remove assets from your household in order to qualify for more need-based financial aid when filling out the FAFSA application.
The greatest ‘power’ of a 529 is tax-free growth, so the earlier you start, the more power the 529 will have.
What is a UTMA:
The Uniform Transfers to Minors Act (“UTMA”) is a custodial account that allows adults to irrevocably transfer money to a minor while maintaining control over those assets until the minor reaches the age of majority in their state (typically 21). At that time, the UTMA will be owned by the child directly and transferred into the child (now adult’s) name.
UTMA’s can be used for any purpose that benefits the child -- they are not restricted to education-related expenses like the 529 Plan is.
UTMA’s are also much more flexible in what types of assets they can own relative to a 529 Plan. Earlier I used the analogy that a 529 Plan is like a 401k Plan in that they have a preset pick-list of mutual funds to choose from – in this analogy, a UTMA is like an IRA in that the investment options are pretty limitless; you can own individual stocks and bonds, ETF’s, REIT’s, crypto, commodities, mutual funds, etc.
UTMA’s are not a tax-free account like 529 Plans are, but they do have a special provision that if your child is not earning income from a job, the first $1,300 of portfolio income (interest, capital gains, and dividends) is tax-free. However, if the portfolio income exceeds $1,300, your child will [generally] need to file a tax return, and income in excess of the $1,300 will [generally] be taxed – this is the “kiddie tax”3. The rules get even more complex if your child has a UTMA and is also employed in any capacity.
3Assuming a 2% annual dividend rate on a hypothetical 100% stock portfolio, a UTMA would be under the portfolio income limits if the UTMA balance were to remain below $65,000. This assumes no capital gains were taken during the year in this hypothetical scenario.
Pros of a UTMA over a 529 Plan:
• Unlimited investment options. This is a Pro for many households, but could also be construed as a Con for those who may feel overwhelmed by needing to build an investment portfolio from scratch.
• No limitations on the use of the funds for “education” related expenses
Pros of a 529 Plan over a UTMA:
• Certain states (such as Colorado) offer state income tax deductions for contributions to a 529
• Certain states (such as Colorado) offer matching contributions to a 529 Plan (only for Colorado-residents with young children also born in Colorado)
• Simplicity – 529 Plans are easy to establish, have a pre-set list of funds to invest in, and are generally simpler to report for tax-purposes than a UTMA
• Parent-Owned 529 Plan’s are viewed ~4x more advantageously in terms of qualifying for Need-based student aid than UTMA’s. And new as of 2024, there is also a ‘grandparent 529 loophole’ where grandparent-owned 529 Plans will no longer count against the financial-aid eligibility of the grand-child student4
4 The Grandparent 529 Loophole will unfortunately not apply to private schools that use the College Scholarship Service (“CSS”) Profile for purposes of financial-aid
Departing Q&A – Ask the Author:
1. Q: Which do you tend to favor – the 529 Plan or the UTMA?
A: One of the principles we subscribe to at True Riches is: “Do not mistake good general financial education for personalized advice”. So with that in mind 😉, I tend to favor the 529 Plan in my home state of Colorado – the State matches the first $500 in contributions for 5 years per kid, the State provides a 4.4% state income tax deduction for contributions, no needing to worry about kiddie taxes if portfolio income is too high, it’s easy to report for tax purposes, and based on the level most people put in to 529’s relative to the cost of college, there becomes little risk of over-funding the account even if only 1 of their children goes to college.
2. Q: Do you have a 529 for your kids personally?
A: I do. However, I only put in the amount the state matches for each kid each year. There’s a specific fact pattern of why I personally don’t put in more, but it’s too complicated to explain for this post – ask me in-person sometime! 😉
