In the world of children’s education savings, 529 plans are commonly touted as a preferred investment vehicle. I beg to differ and am presenting to you today: 529 vs UTMA — the ultimate smackdown.

 

Our Family’s 529 Journey

Nearly a decade ago when we began saving for college costs for our firstborn, it was a given that a 529 savings plan would be a part of the mix. After comparing plans, we chose to begin investing in our state’s 529 college savings plan (in addition to financing a custodial account).

After several years we reevaluated our plan and decided to contribute primarily to each child’s UTMA. This change of plans was due to the flexible nature of the UTMA accounts.

It’s highly likely that each of our children will go on to some form of higher learning after graduating high school. However, we expect them to hold down a job in the summer to contribute to their expenses.

We also understand that, unless they go to a traditional 4-year college, their higher learning expenses might be covered through scholarships and summer employment. With a 529 we were stuck using that money only for higher education.

 

529 vs UTMA: Why We Prefer the UTMA

Sure there’s a tax benefit to the 529 plan (those contributions grow tax-free), but what if the student works hard, earns scholarships, and can cash-flow their way through school without digging into investments?

If that student had investments in an UTMA (in the above scenario) they would have a nice chunk of change to use for another purpose (for example, a vehicle, property, or home purchase).

The only way to evaporate the money in a 529 is to change the beneficiary (if another child in the family needs it for school, rather than the original intended) or take a penalty and pay capital gains tax by making unqualified withdrawals.

When a 529 plan is the best option:

• Your student is destined for college.
• You don’t expect scholarships and employment to cover much of the schooling costs.
• Your student will be attending a particularly expensive university.

When an UTMA is preferred:

• You expect scholarships and student employment to cover all or most of schooling.
• Your child (or children) is likely to choose a career that involves little formal education and more on-the-job training.
• You would like the flexibility of having investments for your child that can be used for purposes other than college.

 

Both Choices Offer Tax Advantages

Both a state-sponsored 529 plan and an UTMA offer tax advantages for your child over simply setting aside money in your own funds (which are taxed at your rate).

The 529 is the tax benefit heavyweight, with all contributions growing tax-free. However, the UTMA also offers a small tax benefit, with a portion of the account earnings being taxed at the child’s rate (rather than your higher rate).

 

Dissenting Voices

I don’t claim to be an expert when it comes to investing. I have a degree in business, and I enjoy researching finance for the benefit of our family.

For us, the benefits of a UTMA outweigh the tax advantage of a 529 plan. Kaye Thomas at Fairmark.com has a series entitled UTMA regret where he writes about immature behavior causing many parents to regret investing in a UTMA.

Additionally, Dave Ramsey recommends investing in an ESA and a 529 plan prior to considering an UTMA. Both Thomas and Ramsey advise these positions because of the tax advantages and the possibility that the child won’t be mature enough to spend wisely.

Both of these men also assume that the student will be going to college. I’m not against traditional degrees, I just can’t guarantee that my children won’t find successful careers outside of that customary path.

 

Can you relate? How have you chosen to invest for your child’s future?