UTMA vs 529: How Are These Accounts Different?

August 29, 2023

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Any parent who has stopped to consider the different expenses related to having a child probably knows what it’s like to have their vision clouded with dollar signs. Raising children can be expensive!

If you plan to help them save for college and early adulthood, it can be even more costly. But there are different tools that you can use to make the cost more manageable. In this UTMA vs 529 review, two of the most popular tools face off to help you decide which one might be right for your family.

A Refresher in Compounding

Any time you are trying to reach a lofty long-distance goal, remember the power of compounding. 

When you earn interest, you earn a percentage of money on the money you initially contribute, often called the principal. Additionally, by leaving your money in your account, your interest starts to earn money as well. This compound interest is what makes investing such an effective tool when it comes to meeting future goals. 

Let’s say that you have $5,000 to set aside. You plan to save this money in a savings account (with a 0.5% interest rate) for 15 years. Then, you plan to contribute an extra $100 per month. At the end of those 15 years, you have $24,032,27

To really make compounding work in your favor, let’s put a compound interest calculator to work again.

Imagine that you decide to invest the money, rather than put it in a savings account. There is definitely more risk, but there is also a lot more reward. Take the exact same scenario as above, but substitute an average interest rate of 6%. In the same amount of time, you now have $39,913.95

Compounding makes investing a powerful tool to meet future goals. But which investment vehicle is right for you when it comes to your kid's future? It’s time to explore two popular choices: UTMA custodial accounts and 529 college savings plans.

In our UTMA vs 529 face-off, see how each tool stacks up and which one might be best for you. 

What is a UTMA?

happy kid

UTMA stands for Uniform Transfer to Minors Act. While the acronym technically represents the act itself, most people use UTMA to refer to the custodial account. So what does this account do?

Understanding Custodial Accounts

The first thing you want to understand is what a custodial account is. Think of it as a financial account with training wheels. The account is set up in your child’s name. However, you — or another adult — are in charge of it until they reach a certain age.

It’s a way for adults to help children manage their money. Then, once they hit adulthood, the training wheels come off, and away they go.

Opening a custodial account is like any other account. You can choose to open one through your brokerage partner (like Vanguard or Fidelity) or a convenient app like UNest.

You will also have to decide what type of account you want–with savings and investments accounts being the two most likely choices. To harness the power of compounding, many families choose an investment account. 

A Closer Look at UTMA

So how does a UTMA account stand out from any other custodial accounts?

A minor can use a UTMA custodial account to receive gifts. While money is certainly the most common gift, the account can also hold patents, real estate, royalties, and even fine art! Minors don’t take possession of the account until they are legal age, which is usually 18 or 21. 

UTMA accounts can also pose a certain tax advantage. The child is technically the owner of the account. That means that the way the earnings are taxed is different. Generally, account earnings in a UTMA are taxed at the child's tax rate, which tends to be much lower than your tax rate.

UTMA Benefits

A big concern that families often have is what to do with college savings if their child doesn’t go to college. Perhaps they take an alternate track after graduation or maybe they cover the cost of college some other way.

One of the biggest UTMA benefits is that the money can be used for anything. So yes, your child could pay for college with their UTMA account. She could also use it for a down payment, to invest in her own business, or to take time off to travel and volunteer. There are no stipulations on how the money is used. 

Additionally, many families really enjoy how the UTMA allows them to guide their child through the financial decision-making process and ultimately pass along ownership to the child when they become an adult.

UTMA Drawbacks

One of the biggest benefits of a UTMA account is its flexibility. However, that flexibility can also be a major disadvantage.

If you create a UTMA with the intention of your child using the funds to pay for college, there is actually nothing that dictates how they spend the money. So she could use the account to cover the cost of college…or anything else! When you set up a UTMA account, you need to make sure that you are comfortable turning over the funds, knowing that they can be used for whatever your child wants. 

Another consideration about UTMAs is how they are viewed in terms of financial aid. You may have heard of the Free Application for Federal Student Aid (FAFSA). In short, it's an application that allows families to apply for different types of federal aid.

A UTMA account is weighted at 20% when your child submits the FAFSA form. That means that students are expected to be able to use 20% of their account balance each year for school. This doesn’t have to be a deal-breaker, but it is worth noting that another college savings option–the 529 college savings plan–counts for much less on FAFSA.

One final consideration in the UTMA vs 529 debate is the fact that the beneficiary of a UTMA cannot be changed. That means that once you open the account in your child’s name, you can’t undo the contributions made to the plan and you can’t change the beneficiary either. 

What is a 529?

college student

A 529 is another popular savings tool. It is specifically designed for educational purposes. When 529 college savings plans were created, their purpose was to cover the costs of post-secondary education at accredited colleges, universities, and trade schools. Examples of what expenses include are:

  • Tuition and fees
  • Supplies and equipment
  • Room and board
  • Computers and other technology equipment

However, thanks to two recent pieces of legislation, the funds in a 529 can also cover some qualifying K-12th grade expenses and apprenticeships.

It is worth noting that these plans do need to be used for qualifying educational expenses or they are subject to both a 10% penalty and federal income taxes.

529 Benefits

When money is set aside in a 529 plan, it is earmarked for educational purposes. That means that you don't have to worry about your child coming of age and using the funds for anything other than educational purposes.

Additionally, if the money is used for educational purposes, there are no taxes on the earnings. This is a sweet tax advantage that can sometimes be stacked with other tax deductions, depending on the plan you choose and where you live.

When it comes to qualifying for federal aid using FAFSA, most 529 plans are weighted a lot less heavy than a UTMA. A UTMA is weighted at 20%, whereas a 529 is weighted at just shy of 6%. That means that your family might have an easier time qualifying for more federal aid.

529 Drawbacks

People often caution against 529 plans because they worry they are too inflexible for an uncertain future. Fortunately, 529 plans are flexible. They simply suffer from a bit of a PR problem.

If your child does not go to college, the funds in their 529 could be subject to a penalty–but not always! If the reason why the money is not needed is due to a scholarship, the amount of the scholarship can be withdrawn tax and penalty-free.

Additionally, a 529 plan can be rolled into another 529 plan. You can also change the beneficiary. All of these strategies allow you to avoid the 10% penalty that comes with using the money for non-qualifying purposes.

Plus, thanks to the Secure 2.0 Act, your 529 plan got even more flexible! Starting in 2024, an unused portion of a 529 plan can be “rolled over” into a Roth IRA. There are some specific parameters you have to follow to qualify. The 529 plan needs to be open for at least 15 years. Additionally, the beneficiary should match the name on the Roth IRA. Lifetime contributions are capped at $35,000, and regular Roth IRA contributions need to be followed too.

While these parameters are still less flexible than a UTMA, they do give 529s a welcome facelift!

Dodge High Fees to Hit Your Financial Goals

typing on a laptop

When it comes to UTMA vs 529, it doesn’t matter which account you pick if you don’t pay attention to fees. As is true with any type of investing, fees related to UTMA accounts and 529 plans can eat away at your financial progress. That is why it is so important to do your research before you start investing.

Looking at the expense ratios might seem overwhelming. But taking the time to pay attention to the various fees that you might incur can save you a lot of heartache and money in the future!

Final Thoughts on UTMA vs 529 

Kids can be expensive! Using the right financial tools can help you move mountains when it comes to financial goals. If you are in a position to help your child save for expenses related to college or adulthood, there are financial tools specifically designed to help with that.

Spend some time exploring various UTMA and 529 options. Consider the benefits and drawbacks of each type of account.

Also, you should know that it is possible to open both accounts for your child as well. If you’re ready to get started with a UTMA, check out UNest as one possible option for a brighter financial future. 

How does UTMA vs 529 stack up for you and your family? Which account have you chosen?

Please let us know in the comments below.

Andy Hill

Andy Hill, AFC® is the award-winning family finance coach behind Marriage Kids and Money - a platform dedicated to helping families build wealth and happiness. With millions of podcast downloads and video views, Andy’s message of family financial empowerment has resonated with listeners, readers and viewers across the world. When he's not "talking money", Andy enjoys being a Soccer Dad, singing karaoke with his wife and relaxing on his hammock.

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