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The Difference Between Deposit Accounts: UTMA & UGMA and 529’s?

The Difference Between Deposit Accounts:  UTMA & UGMA and 529’s?

First, the similarities: 529 custody plans and accounts, such as the UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfers to Minors Act), offer parents other ways to help them pay for their children's education and other university expenses, and private elementary and secondary schools.


One big difference: Deposits can also be used for non-educational purposes, while a 529 plan can only be used (with no negative impact on income tax) to cover the cost of qualified education.

Other important differences between custodian accounts and 529 plans include:

  • Authorized contributions and investment options

  • Ownership and control of funds

  • Savings with tax advantages


Comparison of tax benefits

529 plans have a tax advantage over UTMA and UGMA accounts: The 529 plan allows your investments to grow tax-free, and withdrawals used for tuition, housing and food, and other eligible education expenses are also non-taxable.

There is no limit to 529 distributions for most qualified higher education costs. Still, only $ 10,000 per year per recipient can be withdrawn from 529 tax-free accounts to pay for that beneficiary's elementary and secondary school tuition expenses.

UGMA and UTMA have fewer tax benefits than 529 plans. Typically, the first $ 1,100 of unearned annual income is tax-exempt, and the next $ 1,100 is taxed based on the year's tax child's rate. Income earned over $ 2,200 is taxed at the child's parent rate, which may be higher than the child's rate.


Who controls each of these savings accounts?

If you want to make sure that the money you saved for education expenses is used for this purpose, a custodian account is probably not for you. With a UTMA or UGMA custodial account, the parents or others who create it decide how to invest the assets and how the distributions are used for schooling or anything else for the child's benefit. But as kids get older (usually 18 or 21, depending on the state), they take control and can choose to spend the money however they want.

For 529 accounts, the owner of the account maintains independent control over the beneficiary's age and can switch to a different beneficiary if the first child doesn't need all the money. This flexibility, coupled with tax savings, makes the 529 particularly popular for educational purposes.


What are the rules on investments and contributions?

A custodial account offers more flexibility: it can be funded by any combination of money and investments (usually bonds, stocks, mutual funds, etc.), although UTMA allows contributions of art, real estate, and patents approved by the account's owner or custodian, who is usually the parent or guardian of the minor for whom the account has been created. However, the property is transferred to the minor when he/she reaches the age of majority. The custodian also has a great deal of freedom to invest the assets in the account.

Only cash contributions are permitted for 529 plans, and the investment options are limited to those created for the specific 529 plan. Most plans offer a great value variety of investment options to meet the needs of families investing in education.

529 plans have maximum account balance limits, ranging from $ 300,000 to $ 500,000; however, annual contributions to a 529 plan are not otherwise limited. But any amount you contribute to a beneficiary will be part of the annual donation tax exemption of $ 15,000. Suppose you donate more than that to the recipient's of 529 plan accounts or make other gifts to the recipient in the same year. In that case, the excess contribution or other gifts will be calculated for the federal lifetime gift tax exemption or are subject to income tax donations.

However, there is one exception: The IRS allows you to make five years of contributions at a time, which in 2021 is $75,000 (or $ 150,000 for couples who choose to split gifts) without paying a donation fee. Please note that you will have exhausted the annual exclusion for that beneficiary during those five years if you do. Other contributions to that beneficiary made during that period may be eligible for lifetime federal gift tax relief or maybe the subject of federal donations tax. Please note that if you die before the end of the five years after the original donation, part of the original donation may be included in gross ownership for federal tax purposes.


When would you choose a custodial account over a 529 plan and vice versa?

In short, if your primary goal is to invest in education, 529 plans offer more tax benefits, control, and flexibility. Custodial accounts can be great options for transferring wealth to almost anything else.

If you want to contribute but aren't sure if it will be used for educational purposes, the safest bet would be to deposit it in a custodial account. You or the beneficiary can transfer funds from a custodial account to a 529 account, but you cannot do otherwise without negative tax consequences.


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