One of the most frequently asked questions we get as a financial advisor company in Utah County is, “what is the best way for me to set aside money for my kids?”
From the moment they enter your life, your children are tethered to your heartstrings. It is natural for new parents to want the highest opportunity of success for their children. This may lead parents to wonder, what are the best ways to save money for my kids?
In this article, I will cover some of the more common account types along with the pros and cons of each. First, let’s take a look at a quick comparison of three common ways to save for your child’s education:
UTMA – Uniform Transfer to Minors Act
A UTMA account can be a great way to start saving and investing for your kids; here are a few key points to consider before going all in.
First, UTMA accounts are managed by you (the custodian) but owned by the child (the beneficiary). When your child comes of age of maturity, he/she will have the full legal right to do anything he/she wants with the account. In addition to this, once the custodian has transferred money, he/she cannot move this money to any other account. It is also essential to understand with a UTMA the beneficiary will have full control of the account at the point of maturity. For some parents, this is not a problem, but for others, who may hope the funds be used for something specific such as education, with a UTMA, you will not have that control. Growth made within the UTMA account WILL be taxed. (It doesn’t receive tax-free growth like the 529) It will be taxed on your child’s tax return; the first $1050 is tax-free the next $1,050 will be taxed at the child’s rate, and anything above that will be taxed at the parent’s rate. This will need to be filed annually.
**UTMA Accounts do not have additional benefit when used for education expenses. A UTMA account may reduce the child’s eligibility to qualify for need-based financial aid for college costs. Free Application for Federal Student Aid (FASFA) looks at both the child’s income and parent’s income when determining eligibility for financial aid. Since the UTMA account is considered the child’s, this can play against eligibility. If your income/net worth is enough that makes your child ineligible for FASFA, this portion of information is obsolete.
One of the most significant benefits to a UTMA account is that the money does not have to be used for educational purposes. This allows ultimate flexibility in the distribution of funds for any reason. Another benefit of the UTMA is, you can hold the funds for the beneficiary for up to 25 years. In contrast, a UGMA account usually terminates after 18 years, meaning the day your child turns 18, they will have full legal ownership of the account.
UGMA – Uniform Gift to Minors Act
The UGMA account is nearly identical to a UTMA with the key difference being the age of maturity. While UTMAs allow the ability to wait up to 25 years to transfer the account, UGMA’s are set between the ages of 18 to 21 years of age depending on the state.
Except for that difference, UTMA and UGMAs are very similar.
A 529 Plan, often referred to as a college savings plan, allows you to save and invest for educational expenses. These expenses include tuition and fees (limited to $10k/year for K-12), books, supplies, computers, internet access, room and board, and transportation. A 529 Plan offers the benefit of tax-free growth and tax-free distributions when used for these qualified expenses.
There are many unique benefits to the 529 Plan. One of the most commonly used features is the ability to change the beneficiary of the account whenever you want, penalty free. This means for a family with multiple kids; you don’t need to worry if you overfund the first account, you can simply transfer it to the younger kids as they head off to college.
It is important to note that if the funds are not used for qualified educational expenses, then the earnings will be subject to income tax and an additional 10% penalty when withdrawn from the account.
Which 529 plan should you go with?
Many states have their own unique 529 plan. You can open an account with any state, regardless of where you live. Many states, including Utah, offer a tax credit for residents that contribute to their 529 plan. Utah’s Tax Credit is a 5% credit on contributions up to $2,000 for individuals and $4,000 for married couples. This means that you could receive a maximum credit of $100 for singles and $200 for couples.
Utah’s 529 plan, known as my529, has a great advantage in its low expenses and investment selection. Every year Morningstar names the best 529 Plans based on …“five key pillars: Process, People, Parent, Price, and Performance. [In addition] also consider if plans convey unique benefits, such as local tax breaks, grants, and scholarships…” Utah’s plan has received the highest rating eight years in a row and is considered one of the best policies available.
In summary, it is vital to begin with the end in mind when setting aside money for your kids. Is the main goal to create an education fund, or will the funds possibly be used for something else? Whatever it may be, having all the information available when making the decision can save you tremendous time and energy in the long run.
Here at TrueNorth Wealth, we pride ourselves in the ability to simplify financial concepts and help guide clients to the best choice for their situation when they turn to our financial advisory services in Utah County. We act as a Fiduciary in every capacity, meaning we do what is best for the client, no matter what.
If you are interested in setting up a free discovery session, please call 801-274-1820, fill out a contact form through our website.