12 Jul 529 PLANS VS. UTMA: PROS & CONS

It is not unusual for parents and grandparents (as well as others) to want to help plan for payment of school and other expenses of a beneficiary who is a minor. A UTMA (Uniform Transfers to Minors Act) account is a custodial account usually established by a parent or grandparent at a bank or other financial institution. The custodian of the account invests or withdraws funds for the benefit of the minor until the minor reaches the age of majority (21 in Texas). A 529 plan is normally an education savings plan as it should be used for the future educational expenses of the beneficiary to be able to benefit from the tax advantages described below. Another type of 529 is a prepaid tuition plan that pays for credits at an eligible educational institution. However, this article shall only compare and contrast education savings 529 plans vs. a UTMA account as follows:

TAXES – ADVANTAGE – 529

529 – Earnings and distributions are not taxed provided the distribution is used for tuition, books, computers, room and board, and transportation.

UTMA – Any interest, dividends, etc. is subject to income tax for any income over $2,100 per year at the compressed tax rate that a trust or estate would pay (presently 37% which could be increased to 39.6%).

FLEXIBILITY ON PURPOSE OF WITHDRAWING – ADVANTAGE – UTMA

Distributions for a beneficiary of a UTMA account are not restricted to educational expenses (unlike 529s). If there is a withdrawal from a 529 for something other than educational expenses, then there is a 10% penalty in addition to the federal income taxes due to the income. It should be noted that 529 plans can also use up to $10,000 per year for K-12 private school tuition expenses. So, it is no longer restricted to college education expenses.

AGE REQUIREMENT – ADVANTAGE – 529

There is no age requirement for a 529 since it can even be used for an adult. The custodian loses control of the UTMA account when the beneficiary reaches the age of majority (21 in Texas) as the beneficiary can do anything he or she wants with funds at that time.

CONTRIBUTION LIMIT – ADVANTAGE – UTMA (but only slightly)

There is no contribution limit to a UTMA. In Texas, the lifetime maximum that can be contributed is $500,000 (which should cover the entire cost of college) to a 529.

FINANCIAL AID FOR COLLEGE – ADVANTAGE – 529

Transfers to a UTMA account are considered a gift and the assets of the beneficiary (even they can’t control until the age of majority). However, a 529 is still usually considered as the asset of the parent or donor. Students/beneficiaries are assessed at a 20% rate on the FAFSA application for a UTMA account whereas the 529 is considered a parent asset (if the parent establishes it) and it is only assessed at 5.64% of its value meaning more financial aid could be received if in a 529.

GIFT TAX – ADVANTAGE – 529

Although there is presently an annual gift tax exclusion whereby a donor can give up to $15,000 per year, per person without reporting that gift to the IRS whether the gift is made to a 529 or UTMA account, an individual can contribute as much as $75,000 to a 529 in one year (as if it were spread over five years) for one beneficiary without it reducing the lifetime gift tax exemption amount (presently $11.7 million). The five-year election and any gifts over $15,000 per year, per donee, would need to be reported on IRS Form 709. This could be an estate tax planning strategy for donors with large estates – especially since the lifetime gift tax exclusion and the estate tax exemption are presently subject to attack under the proposed infrastructure plan.

LONG-TERM CARE MEDICAID – ADVANTAGE – UTMA

Long-term care Medicaid (which helps pay for long-term care such as nursing home care) has a five-year look-back period on uncompensated transfers since long-term care Medicaid is “means-tested” (the government assumes you reduced your assets on purpose so that the government would pay for long-term care costs). However, transfers directly to a UTMA account or irrevocable 529 are not a penalized events. Since UTMA accounts are easy to establish and not all 529s are irrevocable, grandparents and great-grandparents use the UTMA account to benefit their grandchildren or great-grandchildren (if under 21) to get government assistance while providing for such beneficiaries.

CHANGE OF BENEFICIARY – ADVANTAGE – 529

You cannot change the beneficiary of a UTMA, but you can change the beneficiary of a 529 not only for another child or grandchild but also to a niece, nephew, and any other eligible family member including yourself.

Whether you should open a UTMA account or a 529 plan depends on your goals. If the goal is saving for college, then generally a 529 plan is better due to the financial benefits. However, if the goal is not college savings and you don’t mind the beneficiary being in control at the age of majority, then a UTMA is often the better option.

If interested in learning more about this article or other estate planning, Medicaid and public benefits planning, probate, etc., attend one of our free upcoming virtual Estate Planning Essentials workshops by clicking here or calling 214-720-0102.  We make it simple to attend and it is without obligation.