Contrary to what you read in the media – and so far this month in my blog – 529 accounts are not the only way to save for a child. Here are a few others.
Uniform Transfer to Minor Accounts (aka UTMA/UGMA or Custodial Accounts)
These accounts have been around forever. The idea is that you open a savings or investment account in the name of a child, with an adult as the custodian.
Pros:
- Can be used for any benefit of the child, not just college costs.Think car, summer camp, private elementary/high school, rehab, sports fees, whatever. College, too.
- Accounts can receive assets other than cash contributions.Someone could transfer appreciated stocks or mutual fund shares to the account.
- Some slight tax benefits:The first $750/year in dividends and capital gains are tax-free. $751-$1500 in dividends and capital gains are taxed at the child’s income tax rate (low). $1,500 and over is taxed at the parents’ rate (higher).
- Can be invested in individual stocks or just about anything.Not limited to target date mutual fund portfolios like most 529 accounts are set up.
Cons:
- Money left in the account has to be transferred to the child by age 21 (in some states, age 18).
- The account is an irrevocable gift to the original child.No changing of beneficiaries if the kid goes off the rails.
- Tax benefits aren’t as good as the 529s.
- Not as good of an estate planning tool as the 529 account for someone who is trying to make a large one-time gift to a child.
Coverdell Education Savings Accounts
These are pretty lame, so I won’t spend a lot of typing on them. This is an education account that can be used for any level of education for the child. But, there is a maximum $2,000/year limit to additions AND there are income limitations ($95k/year single, $190k married) for who can contribute.
The growth is tax-free as in 529 accounts. Money has to be used by age 30. Generally, 1-star, I do not recommend.
Brokerage account in the parent’s name
Yes, there is nothing to say you can’t just invest money in your own account as a parent or grandparent and mentally earmark it for your kid(s). Grow the money over time and gift it (or not) to the kid for college or whatever is needed whenever the need arises.
There is no tax benefit to this, but it offers complete flexibility. Contribute as much as you want each year. No IRS penalties or limits on what the money is used for or when you can withdraw. If your kid makes you mad, take the money and buy new skis or a great purse.
Some people use a combination of accounts to prepare for their child’s future. I see the UTMA and 529 combo often. The most important thing to remember is that before you save for your kid, you must make sure that your own retirement savings plan is in place and being funded.
College investing is a luxury. Retirement planning is a necessity.
