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529 Plans vs. UGMA/UTMA Accounts for College Saving

529s and UGMA/UTMA accounts are both common ways of saving for your kid’s college education. We break down their differences and advantages.

College is one of the most expensive things parents and their children will encounter in their lives. Setting money aside to help pay for it, therefore, is a wise way to get ahead and ensure your child can have the education they deserve. There are many ways to do so, though.

Two of the most common methods of saving money for college or a child’s young adulthood are 529 plans and UGMA/UTMA accounts. In this article, we’ll offer an overview of both and illuminate their advantages, drawbacks, and the key distinctions that separate them. We’ll also give you a better idea of which is more effective for post-secondary saving.

Key Takeaways

  • 529 plans allow you to save and invest for your child’s education and withdraw tax-free for qualified expenses.
  • UGMA/UTMA accounts let you save money for your child to use for any purpose, including education, when they become an adult.
  • A 529’s lesser impact on financial aid is one of many reasons it’s a beneficial option for college saving.

What Is a 529 Plan?

A 529 plan is an account that allows you to save for your or your kids’ education. In short, it allows you to contribute and invest money that you will allocate to one or more beneficiaries. While you can use it for many education levels, including elementary, secondary, and vocational school, most set them up to help fund their children’s college.

A primary benefit of 529s is that they hold tax advantages. Most notably, if the money goes toward qualified expenses related to education, you won’t need to pay any federal income taxes when the time comes to withdraw funds. Examples of qualified expenses include:

  • College tuition
  • Room and board
  • Books
  • Off-campus rent
  • Repayment of student loans.

Within a 529 account, you can invest the money using a limited selection of mutual funds, index funds, or exchange-traded funds (ETFs). Over time, the money will be able to grow by way of regular contributions, investments, and compound interest.

As noted, parents often establish these plans for their children. Anyone can contribute, however, including grandparents, aunts, uncles, siblings, and more. Account owners can also change the beneficiary to a new child, family member, or other person if plans have changed since they originally opened the plan.

What Are UGMA/UTMA Accounts?

Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) are two types of custodial accounts that let parents set aside money for their children until they become adults. It varies by state, but it’s often between 18 and 25 years old.

While many parents use them for funding a child’s college education, the funds can go toward any purpose. It’s important to note that withdrawals count as taxable income. In 2024, $1,250 is exempt from federal income tax; however, another $1,250 beyond that will incur taxes using the child’s tax rate.

A custodian may contribute to the account with no limits. Within it, you can also select investments, such as mutual funds or ETFs, which allow the money to grow beyond cash contributions. However, a crucial aspect of UGMA/UTMA accounts is that they belong to the minor. Contributions are final and will eventually be transferred to the child when they’re old enough.

As mentioned, many parents use UGMA/UTMA accounts to pay for their kid’s college. A potential drawback of this is that the money can affect the child’s ability to receive financial aid. This is because the money technically belongs to them and, thus, will factor into an organization’s decision to give them loans or grants.

Difference Between Them

529s and UGMA/UTMA accounts have very similar goals — often for a parent to save money for one or more of their children. Specifically, this is usually to pay for their college education, which ends up being one of the largest expenses in a child’s and parent’s lives. They also allow anyone — moms, dads, grandparents, and more — to contribute.

The two saving vehicles, however, have several significant differences. Perhaps the most notable of them is in scope. This is because the 529 is restricted to primarily educational expenses, whereas custodial accounts have more freedom, allowing the child beneficiary to use it for any purpose.

Below is a breakdown of the differences between the two side-by-side:

529 PlansUGMA/UTMA Accounts
Generally, only for educational expenses (tax-penalty if not).Money can go towards anything, even if it’s not the custodian’s intended use.
Beneficiary changes are possible if plans change.No beneficiary changes are available.
Tax-free if used for qualified education expensesFederal income tax applies after a certain threshold for all uses.
Minimal impact on financial aid.Can significantly impact a child’s ability to receive financial aid.
Limited selection of investment options available.Can include any investments the custodian chooses, such as stocks, mutual funds, and ETFs.
Can reverse plan contributions.Can’t take back contributions.

Which Method Is Better for College Saving?

529 plans and custodial UGMA/UTMA accounts are common and effective methods of setting aside substantial sums of money for a child’s post-secondary education. They both allow you to invest and enjoy the power of compound interest. As noted, they both also let anyone in your family or beyond contribute. But which one you should choose will depend on your priorities and needs.

On one hand, 529s have the sizeable advantage of tax-free withdrawals, but with the added caveat of needing to go toward college expenses. On the other, UGMA/UTMA accounts can be used for any expense but also come with taxes, especially after withdrawing certain amounts. For college saving? The tax benefit goes to 529 plans.

UGMA and UTMA accounts are also more rigid regarding contributions and beneficiaries than 529s. Unlike the latter, you can’t update the beneficiary of the two types of custodial accounts and once you contribute, the money officially belongs to that person. If you change your mind or the child chooses another path over college, they’ll receive the money anyway. With 529s, you can change the beneficiary and take back contributions if you must.

Another critical distinction is that they have different influences on a child’s higher education financial aid eligibility. For example, a 529 owned by parents for their kid will still have a small negative impact on financial aid because it counts as a parental asset. However, with UGMA/UTMAs, the effect is far greater because all the funds in the account are in the child’s name.

Ultimately, if you’re looking for a plan to help your child specifically pay for college, the 529 is almost always the most effective option. While UGMA/UTMA accounts can be strong vehicles and allow more flexibility regarding non-educational expenses, they’re not as well-defined for college savings as a 529 plan. The smaller effect on financial aid and the control it offers makes it a better choice for college saving.

Frequently Asked Questions

Can you have both a 529 and UTMA/UGMA account?

Yes, you can have both a 529 plan and a custodial account for one or more children. This can allow you to diversify your saving methods and, potentially, take advantage of the different investing approaches each vehicle allows. 529s often have a more restrictive set of options, while UGMA/UTMAs let you invest in a wider range of securities.

Having both account types can also be beneficial if you want a specifically defined account for covering college expenses but would also like to gift money to your child in their young adulthood for other purposes or life milestones, such as buying a house, car, or traveling.

What positive qualities do 529 plans and UGMA/UTMA accounts share?

As we highlighted in an earlier section, the two types of accounts have some specific differences; however, they also have a fair number of similar qualities. Specifically, they both:

  • Allow you to invest and use compound interest.
  • Let anyone contribute.
  • Enable parents to save for their children’s college.
  • Have unique tax advantages.

Can you convert a UGMA/UTMA account into a 529 plan?

You can roll the liquid funds you have within a UGMA/UTMA custodial account into a 529 plan. Then, it will become a UGMA/UTMA 529 plan, or custodial 529. In short, this is a hybrid type of account that takes on different rules and regulations than each counterpart. For instance, unlike traditional 529s, the custodial version, like the regular UGMA/UTMA, is irreversible. You won’t be able to change beneficiaries.