According to the College Board1, the average cost of college for 2017 was $34,740 at private colleges, $9,970 for in-state residents at a public college, and $25,620 for out-of-state residents at a public college. No matter how you look at it – it’s not cheap.
A possible solution? A designated education savings account could be the way to go. But with several ways to save for your child’s education, we understand that it can be tricky knowing where to start. Because everyone’s individual needs are different, there really is no one option that can be recommended for everyone.
However, two very popular choices for education saving are the 529 education savings plan and UGMA/UTMA custodial accounts. Here are some of the aspects of each account to consider.
529 College Savings Plans
As of December 2017, 529 education savings plans can now be used to pay for private elementary school and onward, in addition to college expenses. For those who know their child will be attending a private school, college, or both, and intend on saving money for a majority of the tuition, a 529 Savings Plan could be a suitable option. This tax advantaged investment account allows individuals to contribute towards a beneficiary’s education expenses. Specifically, the tax advantage with these plans is that tax earnings are able to grow tax-deferred and withdrawals are tax-free when used for qualified education expenses. These 529 plans are generally sponsored by individual states, or in some cases, by qualified educational institutions, and are administered by investment companies that oversee the underlying assets.
There are no annual contribution limits for a 529 plan, and contributions are treated as gifts for federal tax purposes. This means anyone can give up to $14,000 a year free from federal gift taxes. Donors also have the option of averaging a single lump-sum contribution over five-years, meaning they could give a gift of up to $70,000 at one time, tax free.
But keep in mind, while there is no annual contribution limit for 529 plans, each plan does have a maximum contribution per beneficiary allowed. These maximums are generous though, usually ranging anywhere from $200,000 to $500,000, depending on the state.
Additionally, you are able to change the beneficiary of a 529 plan without paying a federal income tax penalty if the new beneficiary is an eligible family member of the original beneficiary.
One important aspect about a 529 plan you must remember is this – all money from the account must be used for education-related expenses. This includes expenses like tuition, room and board, books, etc. Using the money for anything other than a qualified education expense will result in a hefty 10% penalty plus additional taxes.
One final note we want to make about 529 is this – the owner of the account will always maintain control over the account. If you are a parent that has opened a 529, you remain in charge of the account even after your child, the beneficiary, has turned 18.
UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) accounts work a little differently. In most states, minors do not have the right to contract and cannot own investments or other assets. For this reason, a trust may be established for the minor and is known as a custodial account. While an UGMA offers a way for a minor to own securities, an UTMA may also allow minors to own other types of property (i.e. real estate, etc.) and provides for inheritance transfers.
While these accounts can be good vehicles for college savings, they aren’t actually solely intended for education savings as 529 plans are. With an UGMA/UTMA account, there are no limitations on how you can spend the funds from the account when a minor becomes an adult. For parents who are not sure if their child will attend college, or believe they will receive a scholarship, then this type of account may make more sense.
UGMA and UTMA accounts also have no limits on contributions, with contributions being treated as gifts subject to the $14,000 annual gift exclusion. UTMA and UGMA accounts are also tax-advantaged, though not in the same way that 529 plans are. The first $1,050 of earning is tax exempt, with the next $1,050 taxed at the child’s rate (assuming he/she doesn’t have any additional income), and the remaining earnings are taxed at the custodian’s rate.
A big different to remember when it comes to UGMA/UTMA accounts vs 529s – the beneficiary of an UGMA/UTMA account gains control of the funds when he/she reaches the age of majority. Since UGMA/UTMA’s don’t have any distribution rules, this means upon reaching adulthood, the child gains full control over the account and can spend the money as they choose. Ideally, it would be spent on education related expenses, but you can’t guarantee that’s how the funds will be used.
Deciding Between the Two
For most people, the decision will come down to three main factors. One, do you want the contributions to be used solely for education as is the case for 529 accounts, or would you rather the funds be used for any desired purpose like funds in an UTMA? Two, who do you want in control of the account until funds are distributed? With a 529 you retain ownership until funds are distributed. With an UGMA/UTMA, the beneficiary gets to take over when of age. Also, keep in mind that the beneficiary of a 529 can be changed, whereas the beneficiary of an UGMA/UTMA cannot. Three, consider how the tax ramifications will impact overall performance. And four, thanks to the latest change in rules for 529 accounts, do you intent on using the funds for private school education before your child reaches college?
Ultimately, before making any decision, you should talk to your financial advisor to decide which plan is right for you and your beneficiary. At Walsh & Associates, one of the areas we specialize in is planning for your education expenses, as part of our comprehensive financial planning service.
- CollegeBoard Trends in Higher Education – Average Published Undergraduate Charges by Sector and by Carnegie Classification 2017-18