529’s and UTMA’s

Investing for a Child’s Future

One of the most common questions we get at Sloan Financial is “What are the options for saving for a child?” There are several ways you can save for your newborn, your toddler, your teenager, your grandchild. Many of us had EE bonds from our parents, some people will do CD’s. In the investment space there are several different options, but two of them are by far the most common: 529 College Savings accounts and UTMA’s (Unified Transfer to Minor Act). Each of them have their list of pros and cons. We tend to not recommend one over the other, it comes down to what your goals and desires are for your child and the money you are saving for them, but there are options whether your child wants to go to college or become a firefighter.

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As with anything in the world of investing and taxes, there are a lot of intricacies and fine details. We are going to run through more of the high level points for 529’s and UTMA’s but would recommend talking to us, another advisor, and/or tax professional to help discuss fine details and for help determining which account would best fit your goals and needs. It’s also worth noting that you don’t have to pick one or the other, you can utilize both if you’d like.

Let’s start with the 529 as it is the one that people tend to be more aware of. A 529 account is an account designed for saving for college or really any secondary education. A 529 account grows tax deferred meaning any dividends, interest or growth are not taxed. Withdrawals made from the account are also tax free when used for what’s called “qualified expenses”. Qualified expenses are the list of approved expenses that a 529 account can be used for. Any withdrawals taken for anything other than a qualified expense would be subject to tax on growth as well as a 10% penalty.

This is often where people get a little weary of 529’s. “What if my child doesn’t go to college or gets scholarships and doesn’t need the funds? Will I be stuck with money that will be penalized?” 529’s have several options for scenarios like this. Funds in a 529 can be passed from one family member to another and you could pass along unused funds to maybe a subsequent child or sibling. Starting in 2024 you are able to convert a 529 to a Roth IRA. This is where some of the intricacies come into play on what’s permitted and what isn’t, but the point is that there are options and ways to utilize the funds without being ‘stuck’ or penalized.

Now let’s look at the UTMA. An UTMA is essentially opening up an investment account in a child’s name. It’s not an IRA, Roth IRA or retirement designated account, just an investment account. Some people may be familiar with a brokerage account. Dividends, Interest and realized capital gains are taxed at the child’s tax rates. An UTMA doesn’t come with a list of qualified expenses though. It offers more flexibility for what you can use the funds for. The child could use the funds to buy a house, buy a car, pay for a wedding, pay for college, or even just continue to invest for future use.

To try to boil it down to an “elevator pitch”: a 529 offers tax free growth and use with the stipulation that funds be used for college, an UTMA is taxed like a normal investment but offers greater flexibility for how funds can be used.

The growth potential when investing for a child is something we would recommend to anyone able and wanting to save for a child. Whether you save for 5 years, 10 years or 20 years for a child, utilizing investments can help grow and multiply the amount of money you save for them. To reiterate, there are plenty of fine details and intricacies to these types of accounts. If you’d like to discuss further and help determine which may be right for you, please get in touch with us, your advisor, and a tax professional.

For more complete information about a 529 college savings plan, including investment objectives, risks, fees and expenses associated with it, please carefully read the issuer’s official statement before investing. It can be obtained from your financial advisor. Any state-based benefit offered with respect to a particular 529 college savings plan should be one of many appropriately weighted factors to be considered in making an investment decision. You should consult with your financial, tax or other advisor to learn more about how state-based benefits (including any limitations) would apply to your specific circumstances. You also may wish to contact your home state of any other 529 college savings plan to learn more about the features, benefits and limitations of that state’s 529 college savings plan.