As a parent, saving for your children’s education is likely among your top financial priorities. With the growing cost of higher education, many parents are saving hundreds of dollars a month, if not more, to make sure their children will be able to attend a quality institution and not have to split their time between school and work.
When saving for your children’s education, you have a few different options in terms of the method you choose. Each offers certain benefits, and each requires careful consideration in light of your finances, your estate plan, and your asset protection needs. As you begin thinking about your children’s college savings, here are some key considerations to keep in mind:
3 Ways to Save for College
There are three primary tools available for parents to put away money for their children’s education costs: 529 savings plans, UTMA/UGMA accounts, and trusts:
1. 529 Savings Plans
The 529 savings plan is a state-sponsored plan that allows parents to save for their children’s college tax-free. As long as you do not exceed the annual exemption (currently $14,000), you can put money into your children’s 529 account without incurring gift tax liability. Additionally, when your children use the funds for qualified educational purposes, their withdrawals are not subject to tax (similar to a Roth IRA). You also have the option to “superfund” a 529 plan by making up to five years’ maximum contributions (currently $70,000) at once without gift tax implications.
Parents own their 529 savings plans. This is an important distinction from UTMA/UGMA accounts, which we will discuss in greater detail below. This means that your children do not have access to 529 assets unless you provide it (which is a desirable control for many parents), but it also means that you need to include provisions for your 529 in your estate plan.
Another key feature of the 529 savings plan is that it is specifically designed for higher education savings. If 529 assets are used for anything other than education related expenses, not only are those expenses subject to tax, but they are subject to a 10 percent penalty as well. If you happen to over-save, or if one of your children earns a scholarship and does not exhaust your 529 savings, you can rollover the excess savings to another related beneficiary (such as another child, a grandchild, or a niece or nephew).
2. UTMA/UGMA Accounts
The Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) are laws enacted at the state level to allow parents to set aside money to be gifted to their children once they reach a certain age (typically 18, 21 or 25). As “uniform” laws, UTMA and UGMA statutes are indeed fairly similar from state to state, but it is still important to understand your state’s law specifically so that you know the precise rules, terms, and conditions that apply.
When you establish a UTMA/UGMA account, the money you place into the account is considered an immediate gift to your child (with potential gift tax implications); however, the account is managed by a “custodian,” and your children cannot access the funds until they reach the age specified. Income earned from UTMA/UGMA account investments is considered the child’s taxable income, and parents may need to report this income on their annual federal returns. Additionally, since establishing a UTMA/UGMA account is equivalent to making an outright gift to your child, you will need to be sure to structure your UTMA/UGMA contributions in line with your overall estate planning goals.
In addition to the potential tax implications mentioned above, UTMA/UGMA accounts have two particularly-noteworthy limitations. First, unlike 529 savings plans, UTMA/UGMA accounts are non-transferrable by the parent. So, if you set up an UTMA/UGMA account in one child’s name, you cannot later move those funds to another child or beneficiary if your originally-designated child does not need the funds for his or her education.
Second, also unlike 529 savings plans, UTMA/UGMA accounts are not education-specific. In other words, when you gift your child money through a UTMA/UGMA, your child can use the funds however he or she sees fit. Once your child is entitled to the funds, he or she is entitled to the funds. So, how the funds are used is entirely up to your child.
A third option for putting away money for your children’s college expenses is to establish a trust. A trust can serve as a kind of middle ground between a 529 savings plan and a UTMA/UGMA account, allowing you to both direct how the funds will be spent and retain the flexibility to adjust to changes in circumstances over time. Depending on the type of trust you choose, a trust can also serve key estate planning and asset protection functions.
Trusts are not specific to college savings, and they are not even specific to making lifetime gifts to your children. Rather, they are flexible gifting and estate planning tools that can be used for a variety of purposes – including saving for your children’s education. As the “grantor,” you decide who will manage the trust’s assets (the “trustee”), how and when you will make contributions, and how and when your children (the “beneficiaries”) will be able to make withdrawals from the trust. While trusts do not offer the same direct tax benefits as 529 savings plans, trusts can be used to mitigate tax liability under various circumstances as well.
Which Option Should You Choose?
So, which option is best for you? As with all legal and financial planning decisions, the answer depends on your unique personal, family, and financial circumstances. Generally speaking, however, UTMA/UGMA accounts have largely fallen out of favor due to the fact that there are other (and typically better) options available. The 529 savings plan was developed after the original UTMA/UGMA laws went into effect, and for most parents the 529 system offers a more-focused and less-expensive solution. If a 529 savings plan is not right for you, establishing a trust is likely to be a better option than opening a UTMA/UGMA account. Of course, everyone’s circumstances are different, and you should be sure to carefully consider all of the options that are available.
To summarize, here are some of the key differences between 529 savings plans, UTMA/UGMA accounts, and trusts established for educational purposes:
Control Over Assets
- 529 Savings Plan – Parents control the account (with limited investment options prescribed by the state)
- UTMA/UGMA Account – The parents designate a custodian who manages the account until the child takes possession.
- Trust – The parents designate a trustee who manages the trust according to the parents’ specifications. The parents can also designate how withdrawn funds are to be used.
Age of Distribution
- 529 Savings Plan – No specific age, but funds must be used for educational purposes to avoid taxes and penalties.
- UTMA/UGMA Account – Typically 18, 21, or 25, as provided for by statute and selected by the parents.
- Trust – Determined by the parents in the trust origination documents.
- 529 Savings Plan – Gift tax exclusion for qualifying contributions (including “superfund” contribution), no tax on qualifying (education-related) withdrawals.
- UTMA/UGMA Account – Standard gift tax exclusion, no withdrawal benefits.
- Trust – No specific tax benefits, but tax planning strategies are available.
Speak with an Attorney at Jiah Kim & Associates About Your Estate Planning Needs
If you would like more information about the college savings options that are available and get help deciding which option is best for your family, we encourage you to contact us for an initial consultation. To speak with a lawyer in confidence, please call (646) 389-5065 or schedule an appointment online today.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.