UGMA vs. 529: What's the Difference, and Which Should I Use?

Saving for college is a major financial goal. Fortunately, you’re not totally on your own when it comes to planning for your child’s future. There are multiple types of college savings accounts that can help your savings reach their best potential, including UGMA accounts and 529 plans. Each account offers unique advantages, and it’s worth learning about them both to decide which option makes the most sense for your plans.

What is a UGMA vs. 529 Account?

Saving for college starts with learning what options are available. A UGMA account or 529 plan can offer advantages that regular bank savings accounts don’t, so many families prefer to use one or both of these options to help their college contributions grow. Understanding the basics on both can help you be more prepared to choose your best option.

UGMA account overview

A UGMA account is a custodial account you can set up on your child’s behalf. Minors can’t legally own certain kinds of financial materials, like stock investments. Putting assets into a custodial account is a way to jump-start an investment mix for kids before they come of age. 

You can think of a UGMA as similar to a trust, except that because the account agreement is already drawn up by the state, it can be simpler to set up a UGMA than to work with an attorney to create a personalized trust fund for your child. UGMAs have some tax advantages over keeping all the investments in your name, and your child can typically take control over the money at age 18 or 21.

Oh, and you can open one through Fabric by Gerber Life.

529 plan overview

A 529 plan is also offered by a state, but it’s specifically designed to help save for education expenses. Almost every state has its own 529 plan, and you don’t need to live in a state to pick its 529 option. Your contributions go into investments (e.g., mutual funds) in the plan. Some people prefer to manage 529 funds themselves, but many plans offer age-based allocation. That means that as your child grows and college comes closer, the plan automatically adjusts to lower-risk investments to help protect your college savings against loss. A 529 plan offers tax-advantaged growth and tax-free withdrawals for qualified expenses.

Differences Between UGMA Accounts and 529 Plans

Both a UGMA account and a 529 plan can help you prepare financially for your child’s future. The plans differ on some key characteristics, which can affect which option makes the most sense for your family.

Who owns the account

A 529 plan may be for your child, but the account owner (e.g., you, the parent) keeps control over the money. You decide how to manage and use the funds, and you can change the beneficiary to another family member at any time without facing tax consequences. This can help make 529 plans flexible and convenient if your plans change, such as if your child gets a full scholarship and you want to use the college savings to send another child (or even yourself) to school.

Money and securities in a UGMA account, on the other hand, belong to the child. Once you contribute cash, stocks, bonds or other investments to the UGMA account, you can’t take it back or change the beneficiary. A UGMA is a custodial account, meaning the account owner has a fiduciary responsibility to manage it in the best interests of the child. These rules help ensure the money gets managed with care until your child comes of age.

How taxes work

A major perk of 529 plans is their tax advantages. Your earnings grow tax deferred, and they’re federal tax free if you use them for qualified education expenses. Most of the time, qualified distributions are also free from state tax.

If you take an unqualified distribution (i.e., using funds for something other than a qualified expense) from a 529 plan, though, you’ll get taxed for the earnings portion and have to pay a 10 percent penalty.

UGMA accounts don’t offer as many tax advantages, although you get at least some tax break. The first $1,150 of unearned income (e.g., investment gains) for a minor are tax free in 2022, and the next $1,150 are taxed at the child’s tax rate, which is usually very low. Any earnings above $2,300 are subject to taxes at the parent’s rate. 

How accounts impact financial aid

Most families plan to use merit or need-based aid to help afford college costs. It makes sense that when you’re saving for college, you’d also want to consider the impact of one account or another on your financial aid eligibility.

The FAFSA, which most colleges use to calculate financial aid, draws an important distinction between student and parent assets. The guiding idea is that parents are responsible for providing a home and supporting the family, while a dependent student’s top financial priority should be paying for their education. In FAFSA’s calculations, parent assets reduce financial aid eligibility by up to 5.64 percent of the asset value, and student assets reduce aid eligibility by 20 percent of the asset value.

A 529 plan is still under the parent’s control and counts as a parental asset. A UGMA counts as a student asset, even if the child is still underage and can’t take control of the account yet. So a UGMA has a much higher dollar-for-dollar impact on financial aid than a 529 plan.

How you can use savings

One of the joys of parenthood is seeing your kids’ individual personalities and passions bloom. These savings can be a way to support kids as they follow the path that’s best for them.

Funds in a 529 plan are meant to go toward education. The IRS sets specific, “qualified education expenses” like tuition and fees, textbooks and equipment. If the student is enrolled at least half-time, room and board can also count as a qualified expense. You can use 529 savings toward educational programs like vocational or culinary school as well as a four-year university. But if your child’s plan looks more like skipping college to launch a new company, taking seed money from the 529 won’t count as a qualified distribution. Your choice is to change the 529 beneficiary to a different child headed for college, or deal with taxes and penalties.

UGMA accounts don’t restrict how your child uses the funds. Once they come of age, the account is theirs to use as they wish. This can make a UGMA a more flexible choice if your child wants to use money for a world-traveling gap year, a down payment on a home or of course education. (For example, here's why one mom chose to open UGMA accounts for her kids.)

Should You Choose a UGMA or 529 for College Savings?

The choice between a UGMA account, a 529 plan or both comes down to a few factors. 

First, ask yourself how certain you feel that college is in your child’s future. A college education can be a great way to pursue learning and prepare for a career, but it’s not the only way. You’ll face taxes and penalties if you use 529 funds for unqualified expenses, so if college feels more “maybe” than “yes,” a UGMA account may offer the flexibility you prefer. If you think it’s highly likely that you’ll use funds for college (either for your child or another beneficiary), a UGMA can’t match a 529 plan’s tax advantages.

Next, consider financial aid impact. UGMA accounts will take a bigger bite out of financial aid eligibility than a same-sized 529.  

You should also consider how much control you’d prefer to keep over college contributions. A 529 plan belongs to you. You decide how to use the money, and you can even change the beneficiary. This can be helpful if your child doesn’t need all of their college savings and you want to put extra funds toward another child’s tuition. A UGMA account ensures the funds go to your child, which may help you feel confident that they will have the money they need to start their adult life.

For many families, a 529 plan offers the best tax advantages to grow college savings as much as possible. But a UGMA account can help you plan for unqualified-but-still-important college expenses like traveling with friends, or save for living expenses or milestones after college. You might find that putting a portion of your savings in both accounts helps you get the widest range of advantages.

Fabric exists to help young families master their money. Our articles abide by strict editorial standards.

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