Author Topic: 529 vs UTMA  (Read 1470 times)

redrocker

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529 vs UTMA
« on: January 13, 2017, 09:06:22 AM »
First addition to the family arrived last year and family has given a few hundred dollars towards his future education. I initially thought I would open a UTMA so I wouldn't be bound to use the money for college expenses and to have flexibility with investments without the caps and extra rules from a 529.

However when I went to Vanguard and I couldn't get their 529/UTMA comparison tool to work, I googled to see what my state (Louisiana) has for a 529. I'm kinda surprised by the advantages it has and I wanted to post here to see if I'm missing something.

The Louisiana 529 (START) offers an "earning enhancement", basically a percentage based match towards annual deposits based on your AGI. Looks like we'd qualify for 12% on annual deposits up to 5x the annual cost of attending college at the most expensive state college.

Reported AGI Rate Earnings Enhancement
$0 to $29,999 14%
$30,000 to $44,999 12%
 $45,000 to $59,999 9%
$60,000 to $74,999 6%
$75,000 to $99,999 4%
$100,000 and above 2%

Earnings on START accounts are tax deferred until withdrawn. If the funds are used to pay Qualified Higher Education Expenses, the earnings are exempt from both state and federal taxes.

Deposits to a START account are deductible from Louisiana State Taxable Income up to a maximum of $2,400 per year, per account, and any unused portion may be carried forward to subsequent tax years on individual returns

Fund choices include:
VTWSX
VITSX
VGTSX
Vanguard small, mid, large cap index funds

If you move to a different state, you can roll over your START account to another 529 plan but all Earning Enhancements and interest thereon will be forfeited.

If the monies are refunded, the earnings included in the refunded amount become taxable by the federal and state governments and may be subject to a 10% (of earnings) penalty tax imposed by the IRS. Monies withdrawn up to the value of scholarships will not be subject to the 10% additional tax. Refunds will not include any Earnings enhancements.



So, considering I was probably going to put his money in the US total stock market index fund anyway and with the combined earning enhancement and tax deduction this seems like a slam dunk. Primary catch would be if we move to a different state, which considering college is 18 years away from him is a pretty good possibility.

Any thoughts from parents here who have made similar choices?

NeonPegasus

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Re: 529 vs UTMA
« Reply #1 on: January 13, 2017, 12:18:55 PM »
If anyone could explain why a UTMA would be worthwhile, I'd love to hear it. About the only thing I can think of are tax savings, but that's offset by (a) your child having the ability to take all of the money in the account once they're 18 and blowing it on hookers and blow and (b) it directly counting against them in decisions about financial aid.

529 will give you some tax writeoff for your state. I calculated in GA that $12k contributions would save $720 in taxes. And it would grow tax free. The earnings enhancement thing for the LA 529 is pretty cool and makes it a slam dunk from what I can see. In your case, I would save at least up to the earnings enhancement match. After that, I'd consider putting other money in an account in your name. That way, you direct the money and it can go to your child even if college is not in their future.

redrocker

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Re: 529 vs UTMA
« Reply #2 on: January 14, 2017, 10:31:43 AM »
Thanks for replying. Reading up on this has made me rethink my previous aversion to putting money in a 529.

seattlecyclone

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Re: 529 vs UTMA
« Reply #3 on: January 15, 2017, 12:07:45 PM »
If anyone could explain why a UTMA would be worthwhile, I'd love to hear it. About the only thing I can think of are tax savings, but that's offset by (a) your child having the ability to take all of the money in the account once they're 18 and blowing it on hookers and blow and (b) it directly counting against them in decisions about financial aid.

UTMA can be worthwhile for the tax savings. Many people who use these accounts won't qualify for anything in the way of financial aid anyway. Your downside (a) is relevant to your situation, but perhaps not all. As to the question of whether the kid would use the money irresponsibly, every kid is different. Just because they have a legal right to use that money as they please, it doesn't mean that you as parents can't impose consequences if they do use the money in a way that you don't approve of.

Also it's possible to spend the money before they turn 18. Transfer some appreciated stock into the UTMA account, sell it and get the first $2k of income tax-free, and spend the proceeds on something you were going to give the kid anyway. You aren't supposed to use this money for something that you're legally required to provide as parents (food, clothing, housing, medical care, etc.) since the money is theirs once it hits the account, but any "extras" like music lessons or summer camps or a video game system or something along those lines seems like fair game.
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SeattleCPA

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Re: 529 vs UTMA
« Reply #4 on: January 19, 2017, 07:42:36 PM »
If anyone could explain why a UTMA would be worthwhile, I'd love to hear it. About the only thing I can think of are tax savings, but that's offset by (a) your child having the ability to take all of the money in the account once they're 18 and blowing it on hookers and blow and (b) it directly counting against them in decisions about financial aid.

UTMA can be worthwhile for the tax savings. Many people who use these accounts won't qualify for anything in the way of financial aid anyway. Your downside (a) is relevant to your situation, but perhaps not all. As to the question of whether the kid would use the money irresponsibly, every kid is different. Just because they have a legal right to use that money as they please, it doesn't mean that you as parents can't impose consequences if they do use the money in a way that you don't approve of.

Also it's possible to spend the money before they turn 18. Transfer some appreciated stock into the UTMA account, sell it and get the first $2k of income tax-free, and spend the proceeds on something you were going to give the kid anyway. You aren't supposed to use this money for something that you're legally required to provide as parents (food, clothing, housing, medical care, etc.) since the money is theirs once it hits the account, but any "extras" like music lessons or summer camps or a video game system or something along those lines seems like fair game.

Agree with SeattleCyclone's good comments.

Also, this two cents from my personal experience of saving money for daughters' college costs (starting the day they were born...) For both my girls (now full grown women), the UTMA worked way better than a Sec. 529 plan would have. They were able to accumulate decent sums, pay essentially zero tax, have maximum flexibility...

P.S. I didn't have a choice BTW. Sec. 529 plans weren't available when they were born.
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wannabe-stache

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Re: 529 vs UTMA
« Reply #5 on: August 29, 2017, 08:40:07 AM »
If anyone could explain why a UTMA would be worthwhile, I'd love to hear it. About the only thing I can think of are tax savings, but that's offset by (a) your child having the ability to take all of the money in the account once they're 18 and blowing it on hookers and blow and (b) it directly counting against them in decisions about financial aid.

UTMA can be worthwhile for the tax savings. Many people who use these accounts won't qualify for anything in the way of financial aid anyway. Your downside (a) is relevant to your situation, but perhaps not all. As to the question of whether the kid would use the money irresponsibly, every kid is different. Just because they have a legal right to use that money as they please, it doesn't mean that you as parents can't impose consequences if they do use the money in a way that you don't approve of.

Also it's possible to spend the money before they turn 18. Transfer some appreciated stock into the UTMA account, sell it and get the first $2k of income tax-free, and spend the proceeds on something you were going to give the kid anyway. You aren't supposed to use this money for something that you're legally required to provide as parents (food, clothing, housing, medical care, etc.) since the money is theirs once it hits the account, but any "extras" like music lessons or summer camps or a video game system or something along those lines seems like fair game.

I was wondering if this was possible as well.  I am in the top tax bracket so i thought instead of selling stock and paying 23.8% cap gains taxes, why not transfer to UTMA and either sell or tax gain harvest opportunistically up to $2,100 every year?

Also, what are the paperwork requirements?  If i pull money out to pay for child care or band camp or whatever, do i need to keep these receipts?

Paul der Krake

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Re: 529 vs UTMA
« Reply #6 on: August 29, 2017, 08:54:03 AM »
Wow, the LA 529 is an insanely good deal. They even let you carry forward the unused tax deduction to future tax years.

It doesn't matter if you move to another state down the line, you can have multiple 529s for the same beneficiary.

seattlecyclone

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Re: 529 vs UTMA
« Reply #7 on: August 29, 2017, 12:15:03 PM »
If anyone could explain why a UTMA would be worthwhile, I'd love to hear it. About the only thing I can think of are tax savings, but that's offset by (a) your child having the ability to take all of the money in the account once they're 18 and blowing it on hookers and blow and (b) it directly counting against them in decisions about financial aid.

UTMA can be worthwhile for the tax savings. Many people who use these accounts won't qualify for anything in the way of financial aid anyway. Your downside (a) is relevant to your situation, but perhaps not all. As to the question of whether the kid would use the money irresponsibly, every kid is different. Just because they have a legal right to use that money as they please, it doesn't mean that you as parents can't impose consequences if they do use the money in a way that you don't approve of.

Also it's possible to spend the money before they turn 18. Transfer some appreciated stock into the UTMA account, sell it and get the first $2k of income tax-free, and spend the proceeds on something you were going to give the kid anyway. You aren't supposed to use this money for something that you're legally required to provide as parents (food, clothing, housing, medical care, etc.) since the money is theirs once it hits the account, but any "extras" like music lessons or summer camps or a video game system or something along those lines seems like fair game.

I was wondering if this was possible as well.  I am in the top tax bracket so i thought instead of selling stock and paying 23.8% cap gains taxes, why not transfer to UTMA and either sell or tax gain harvest opportunistically up to $2,100 every year?

Seems reasonable to me. I've been meaning to do this with our son and haven't gotten around to setting it up yet.

Quote
Also, what are the paperwork requirements?  If i pull money out to pay for child care or band camp or whatever, do i need to keep these receipts?

Good question. This Fairmark article mentions that you need to keep records:

Quote
Note: As custodian, you’re supposed to be able to account for where the money went. If you pulled money from the account to buy a computer for your child, make a permanent record of this fact.

This other article tries to claim that any expenditure out of the account is probably illegal, but all of the examples in there are for expenditures that were either not for the benefit of the child or made up some of the parent's support obligation. Don't do that.

Keep good records and don't spend the money on yourself or things you're required to buy for your child, and it seems you'll probably be fine.
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PathtoFIRE

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Re: 529 vs UTMA
« Reply #8 on: August 29, 2017, 01:51:19 PM »
We use 529s, and recently my oldest (age 8) has gotten interested in investing his own savings and so I opened a UTMA for him with Vanguard. UTMA/UGMA are unfavorable for financial aid, but my assumption has been that if he decides to use his savings for college, he can transfer them to a custodial 529, pay negligible income tax (assuming he's not working much) in high school on his return, and then eliminate that asset from FAFSA consideration. This way he maintains the flexibility to use those funds for something else or not at all if he chooses. Anyone see any problem with that plan?

seattlecyclone

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Re: 529 vs UTMA
« Reply #9 on: August 29, 2017, 03:58:45 PM »
I'm not so sure about that. Perhaps you could transfer the money to a 529 in the kid's name (rather than in the parent's name as is usual), but I don't think that would change the treatment under FAFSA. This is a bit beyond my knowledge though. A better bet might be for the kid to get a job while in high school and move some money from the UTMA to an IRA, where it would be completely invisible to the FAFSA.
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GizmoTX

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Re: 529 vs UTMA
« Reply #10 on: August 29, 2017, 08:33:34 PM »
We have a nephew with a big UTMA funded by his grandparents, & at age 25 he's still unemployed, hasn't finished school, & is directionless. The money is letting him drift along instead of making the hard decisions. Very sad.

protostache

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Re: 529 vs UTMA
« Reply #11 on: August 31, 2017, 06:53:37 AM »
We have a nephew with a big UTMA funded by his grandparents, & at age 25 he's still unemployed, hasn't finished school, & is directionless. The money is letting him drift along instead of making the hard decisions. Very sad.

So you're saying your nephew is FIRE. Sweet!

GizmoTX

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Re: 529 vs UTMA
« Reply #12 on: August 31, 2017, 02:22:43 PM »
NOT SWEET. Nephew is certainly acting as if he has reached FIRE, but the money will run out in 4 years even with the most frugal spending if/when he gets kicked out. His dad/my brother says he is expected to leave, but hasn't enforced it; he doesn't do confrontation & it's so easy for nephew to not have to do anything. I'm afraid it's going to be tough to explain to an employer why he hasn't been doing anything for years. 

trollwithamustache

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Re: 529 vs UTMA
« Reply #13 on: September 06, 2017, 08:36:20 AM »
Our accountant advices UTMA, and here is the logic:

the 529 sets you up for failure come college financial aid application time because they look at that money first before you get any aid.

Then they look at income. If you have MMMd you may not have any or may be able to artificially lower yours for the years that count.

Then they look at total assets and since you are on this board, there is a good chance you are F&#@ed in that category.

If you trust the family members, the best thing is to keep the money they contribute in a separate account they set up and own for the college money and it will never show up on your Aid application.

Paul der Krake

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Re: 529 vs UTMA
« Reply #14 on: September 06, 2017, 09:06:07 AM »
What? UTMA are definitely counted in the financial aid formula, and as a student asset.

reeshau

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Re: 529 vs UTMA
« Reply #15 on: September 07, 2017, 09:55:36 AM »
If you trust the family members, the best thing is to keep the money they contribute in a separate account they set up and own for the college money and it will never show up on your Aid application.

Troll,
This sentence threw me at first.  I see the point that here you are talking about *contributors*, not the beneficiaries.  But if it is an UTMA, it is still the kid's asset.  If you don't report it, that's a reporting error, not a loophole.

For the rest of your reply, I agree with Paul--I think your accountant has it backward.

From finaid.org:  http://www.finaid.org/savings/accountownership.phtml

"For financial aid purposes, custodial accounts are considered assets of the student. This means that custodial bank and brokerage accounts have a high impact on financial aid eligibility."

"Child assets are assessed at a rate of 20%. (Before July 1, 2007, child assets were assessed at a rate of 35%.) Parent assets are assessed on a bracketed system, with a top rate of 5.64%. This represents a difference in financial aid eligibility equal to 14.46% of the asset."

bb5999

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Re: 529 vs UTMA
« Reply #16 on: September 07, 2017, 10:05:41 PM »
Our accountant advices UTMA, and here is the logic:

the 529 sets you up for failure come college financial aid application time because they look at that money first before you get any aid.

Then they look at income. If you have MMMd you may not have any or may be able to artificially lower yours for the years that count.

Then they look at total assets and since you are on this board, there is a good chance you are F&#@ed in that category.

If you trust the family members, the best thing is to keep the money they contribute in a separate account they set up and own for the college money and it will never show up on your Aid application.

Whoa....I was just taught that 529 is preferred over custodial accounts, in regards to pursuit of financial aid. See this thread for related topic: https://forum.mrmoneymustache.com/mini-money-mustaches/tifu-by-building-custodial-accounts-for-two-kids-for-education-savings/

PathtoFIRE

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Re: 529 vs UTMA
« Reply #17 on: September 08, 2017, 08:39:19 AM »
Just to note, UTMA/UGMAs can be transferred into custodial 529 accounts. While the minor continues to be the owner of the custodial 529, as long as they are a dependent they get to report the custodial 529 as a parental asset rather than a personal one (this was not always the case, but the law changed a few years ago). This is a way to "clear" any UTMA/UGMAs before the student submits FAFSA.

We are using both individual 529s (ones owned by a parent or other non-beneficiary) for direct college savings for each kid, and we are using a UTMA for my oldest who decided to invest his savings rather than just store it in his piggy bank.

Chesleygirl

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Re: 529 vs UTMA
« Reply #18 on: September 09, 2017, 01:27:59 PM »
Isn't UTMA the same thing as UGMA (Unifom Gift to Minors Act). My attorney talked to me about that. I decided against it, because the kid gets all the money once he turns 18 or 21. Many people that age often don't make good decisions and I decided, I didn't want to give my daughter that lump sum of money at a young age.
I decided a 529 plan would be better for many reasons. If she decides not to attend college, the money can be transferred into one of the 529 plans for our other kids, without incurring any penalties.

seattlecyclone

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Re: 529 vs UTMA
« Reply #19 on: September 11, 2017, 01:00:57 PM »
Isn't UTMA the same thing as UGMA (Unifom Gift to Minors Act). My attorney talked to me about that. I decided against it, because the kid gets all the money once he turns 18 or 21. Many people that age often don't make good decisions and I decided, I didn't want to give my daughter that lump sum of money at a young age.
I decided a 529 plan would be better for many reasons. If she decides not to attend college, the money can be transferred into one of the 529 plans for our other kids, without incurring any penalties.

UTMA is an updated version of UGMA. Most states have adopted the newer UTMA rules. I think that for most purposes you can consider the two as being essentially the same thing.
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