UGMA, UTMA, 529 and More: What’s the Best Option to Save for College?

There are lots of different ways to approach saving up for your kids’ future education. Saving for college in a combination of plans, including 529 savings plans and UGMA accounts, can offer best-of-both-world advantages for kids’ educational future.

How 529 College Savings Plans Work

For a lot of parents, college savings and “529” can become almost synonymous. Do 529 plans just have a stellar marketing team, or are they actually worth the hype? Here’s the benefits and drawbacks of this popular college planning option.

529 plan benefits

Many times, when you hear “529 plan,” this means a 529 savings plan. There’s another type, the 529 prepaid tuition plan, that works differently. A 529 savings plan does offer some eye-catching benefits:

• Tax-free growth and tax-free distributions (i.e., withdrawals) for qualified education expenses

• High contribution limits and low minimums

• Account owner can change the beneficiary anytime, which allows flexibility

• Qualified education expense include college costs like tuition, room and board and supplies, as well as certain K-12 or student loan expenses

By contrast, a 529 prepaid tuition plan lets you buy “credits” equivalent to a certain amount of tuition (e.g., a semester) at participating colleges. The main advantage is you lock in current rates, so you’ll pay the same for each credit over the years, even if the sticker price of tuition rises. That said, this approach generally locks your child into which institutions they might attend.

529 drawbacks

Some folks present a 529 savings plan as the gold standard. While this is often a strong option for families, it’s important to consider drawbacks of any plan, too:

• Restricted spending: Money in a 529 savings plan has to go toward qualified education expenses, or you’ll face taxes and a 10 percent penalty. For example, airfare to study abroad doesn’t count as a qualified expense.

• Smaller window of time per person: Savings in a 529 plan don’t expire, but because of the qualified education expense rule, your child may feel like there’s a tighter window to use those funds during their education years. You can change the beneficiary if there’s money left in the plan, but each beneficiary may have a limited window of use from the account.

• Shorter college list: For 529 prepaid tuition plans, you’re relying on the premise that your child will choose to go to a participating college. If they go somewhere else, or don’t go to college at all, you can generally get your money back (possibly minus interest), but you could be at a steep disadvantage if tuition prices have increased a lot since you opened the plan.

Alternative Options to Save for College

While 529 plans tend to get lots of time in the spotlight, other accounts can also offer meaningful advantages to help you save for college.

Coverdell

A Coverdell education savings account also offers tax-free growth and distributions for qualified education expenses. One advantage is qualified expenses include things like books, supplies or tutoring for K-12 grades, whereas a 529 plan only covers up to $10,000 in K-12 tuition. A disadvantage is you’re limited to contributing $2,000 per year total for each beneficiary (e.g., your contributions and grandparents’ both count toward that total).

UGMA and UTMA accounts

Saving for college doesn’t always have to happen in a college-specific account. Building some savings in a custodial account for your child, such as an UGMA or UTMA account, can help set them up for success after they leave home.

Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts are two types of custodial accounts, meaning you can save money and assets in your child’s name before they’re old enough to do things like buy stocks for themselves. The main difference between them is that an UTMA account can hold physical assets (e.g., real estate, heirloom jewelry) while an UGMA can only hold financial assets (e.g., cash, securities, investments).

Some advantages include:

• Use money as needed: UGMA and UTMA accounts don’t have “qualified” expenses, so your child can use the funds however they feel is best without penalty.

• Money goes where intended: Any contribution to an UGMA or UTMA becomes the beneficiary’s property. A 529 account owner could theoretically take unqualified withdrawals and deplete the account, but this isn’t possible with a custodial account.

• High contribution limits: You can contribute up to $17,000 per year, or $34,000 for a married couple, without facing gift tax consequences. 

• Lower tax rate: The first $1,250 of custodial account earnings may be exempt from taxes for a minor. The next $1,250 gets taxed at the child’s rate rather than the parent’s, which generally means a much lower rate.

UGMA and UTMA disadvantages to keep in mind include:

• Fewer tax advantages: You don’t get the same degree of tax-free growth on investments that you would with a 529 plan.

• Minor is account owner: This can be an advantage or disadvantage — the account assets are protected for your child, but you sacrifice control or the option to switch beneficiaries if your plans change.

• Greater impact on financial aid: The FAFSA, which helps determine eligibility for need-based aid, views parent and student assets differently. Student assets count more heavily against financial aid. Because a custodial account belongs to the child, the funds in it affect financial aid dollar for dollar more than funds in a 529 plan.

How to Choose College Savings Options

Every child and every family is different, so your college savings strategy will be, too. Here’s some tips to find your right fit.

• Consider your values and savings strategy: Are you confident your child will go to college or a vocational school? If so, it’s difficult to outdo a 529 savings plan in terms of tax advantages. Are you interested in a more holistic approach to launching your child into adulthood and offering financial support for milestones like a first apartment or a wedding, in addition to education? In that case, an UGMA or UTMA can help your child get established, wherever their plans and accomplishments take them.

• Divide and conquer: You don’t need to load all your savings into one account. It might make sense to open a 529 plan and a custodial account and set specific savings targets for each.

• Save consistently: Don’t let sticker shock over college prices freeze you in place. The truth is that saving bit by bit really does add up, especially if you start when kids are little and stick to a savings routine.

Creating savings plans is a chance to envision your child’s future. A thoughtful, balanced approach to factors like tax advantages and spending flexibility can help you prepare kids to succeed, whatever lies ahead.

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

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

Information provided is general and educational in nature and is not intended to be, and should not be construed as, financial, legal, or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. We make no warranties with regard to the information or results obtained by its use, and disclaim any liability arising out of your use of, or reliance on, the information.

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