Choosing a Tax-Advantaged Account for College Saving — Part 2

Choosing a Tax-Advantaged Account for College Saving — Part 2

Do you want to send your child to college? In our last blog on different tax-efficient investment accounts, we discussed the most popular college savings plan, the 529 Plan. Today, we’ll discuss another option: UGMA/UTMA accounts.

UGMA/UTMA Accounts
 

Not all college savings strategies require the involvement of a college or a state government. Following guidelines established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA)—each state uses either one or the other—adults such as parents and grandparents can establish and contribute to a custodial account in a minor's name without having to establish a trust or name a legal guardian.

There are some slight differences between the two types of accounts, but let’s talk about the similarities first.

  • Both are managed by custodians
  • Parents, grandparents, relatives and friends can make irrevocable transfers in any amount to the account
  • If the donor, acting as custodian, dies before the funds are turned over to the child, the account may be taxable as part of the donor’s estate

Difference between the two include

  • UTMA law allows virtually any kind of asset, including real estate, to be transferred to a minor
  • UGMA law limits gifts or transfers to bank deposits, securities (including mutual funds), and insurance policies

Contributing to an UGMA or UTMA account can accomplish two goals simultaneously: helping a future student prepare for college costs and reducing the value of a contributor's taxable estate.

UGMA/UTMA accounts also offer favorable tax treatment of investment earnings. For example, the first $1,000 of earnings is tax-free each year. If the minor is under 19, earnings in excess of $1,000, but not above $2,000 are taxed at the child's rate. If earnings exceed $2,000 for children under 19, the income is taxed at either the parents' rate or the child's rate, whichever is higher. If the child is older than 19, all income is taxed at his or her rate. Note that the age limit increases to 24 for a full-time student if the child doesn't have earned income in excess of half of his or her annual support.

Despite the obvious appeal of UGMA/UTMA accounts, it's worth noting that the assets in the account belong to the child, not to the contributor. When the child reaches legal adulthood at age 18 or 21, depending on the state, he or she is free to spend the money with no restrictions. In other words, contributors cannot force that individual to use the money for college costs.

In our final blog in this series, we will look at one more option for tax-advantaged college savings: Coverdells.