What every parent should know about UTMAs

Let’s say you had a baby today. Way to go, you. Second, maybe get some rest and read this later? Third, start saving some money — according to the cost calculator at the nonprofit College Board, four years of higher learning will cost $222,466 in 18 years. And that’s for in-state tuition at a public institution. If Junior goes out of state, or to a private school, college could run you as much as $438,000. Suffice it to say that, for most of us, that’s a significant chunk of change.

That’s why 529 college savings plans, created by the federal government in 1996 and adapted over the years since, are so important. They’re a little like a 401k for education or college costs. All growth is tax-deferred, meaning you pay no taxes on it while it’s invested — and in some states, certain contributions are tax-deductible.

Then, when it’s time to send Junior to college, you can withdraw that money tax-free, so long as you use that money on a qualified expense, like tuition, room-and-board, even computer equipment. (Please note: Specifics vary by state, though nothing prevents you from using a fund run by a state other than the one where you live.) Thanks to a 2017 change in tax law, you can also use a 529 for private elementary and secondary school expenses.

Sounds great, right? And for the most part, it is. That said, there are drawbacks. 529s have strict definitions of qualified expenses, so you might still face out-of-pocket costs down the road. Then there’s the unknown — anything from your child choosing not to go to college, to your child receiving a full-ride scholarship. (And hey, you never know — one recent proposal would make some types of college education free for certain families, in which case you might need to figure out something else to do with all that saved money.) But, hey, college is expensive, so having a little extra savings is never a bad thing.

So what if there was another way? It turns out there is. It’s called the Uniform Transfers to Minors Act (UTMA), a type of custodial account that allows parents or other caretakers to pay expenses for anything child-related, including tuition. We spoke with Ksenia Yudina, founder and CEO of UNest, a money app designed to help parents invest in their kids’ future, to understand more.

What is a UTMA account?

A UTMA is what’s known as a custodial account. In short, it’s a way for parents to save money for their children, who will then gain control of the account when they turn 18 or 21, depending on the state. It’s a simple process — an adult creates the account, contributes to the account, manages the account, and then eventually transfers it to the beneficiary. You can think of a custodial account like a type of trust account.

Other adults can contribute to the uniform gift account as well, and because contributions are considered a gift, only contributions greater than $15,000 are subject to a gift tax. Also, the custodial account will be subject to income tax and/or capital gain taxes similar to other investment income accounts.

In the event that the transferor passes before the trustee is of age to receive the uniform transfer, the custodianship will need to be reassessed. At this time, a nominated custodian will take the responsibility over the UTMA transfer account, and they will become a successor custodian until the minor is of age to receive the UTMA assets.

Speaking of taxes, the first $1,100 of annual earnings are tax-free, and the next $1,100 are taxed at the child’s rate (which is typically lower, and therefore advantageous to the adult making the contribution). Gains beyond that are taxed at the adult’s rate — but again, those are gains, not contributions. Finally, note that, unlike a 529, which can only be funded through cash contributions, a UTMA account can be funded through a variety of methods, including stocks, bonds, mutual funds, and cash. UTMAs can also even include fine art or property for a minor beneficiary. In terms of custodial capacity, this offers a greater flexibility for parents when making decisions around their estate planning.

How does it work?

You’ll start by opening a UTMA account with a trusted financial service provider, and name a minor beneficiary. Every year, you can contribute up to $15,000 per individual (or $30,000 for a married couple). That money is managed by the personal representative or financial institution, and, as mentioned above, can be invested in a wide variety of things. Once the account’s beneficiary turns the legal age (again, it varies by state), the beneficiary can use the account for anything — tuition, room-and-board, college savings, down payment on a house or car, even a wedding. In some situations, it might even make sense to roll the money into a 529, which would reduce any potential impact on financial aid.

You might consider a service like UNest for your UTMA account as well. UNest is a registered investment advisor (RIA). The service costs $3 per month and you can set up a UTMA account in minutes after downloading UNest’s mobile app. From there, you can set up a monthly contribution — the minimum is $25.

The advantage to using UNest is that, thanks to partnerships with the likes of Disney, Nike and Old Navy, you can also earn additional contributions by shopping or taking action with one of those partners — including Haven Life. All Haven Life customers are eligible for a free $25 contribution to their UNest investment account simply by signing up. And if, for some reason, you’re not already a policyholder, you can get a quote with Haven Life, and receive a $5 contribution. (UNest also has a referral program where you can earn contributions for turning friends on to the service.)

What can it be used for?

“You can use the funds for anything child-related, whether that’s swim lessons, a first car, or college,” says Yudina. “Flexibility is key, particularly as parents are questioning how sustainable the cost of college is for their kids.” Indeed, this flexibility is a huge part of the appeal of a UTMA. The reality is, college is expensive — but so is life. Setting up a UTMA helps provide coverage in case the financial challenge of tomorrow lies outside the arena of education.

What are some of the pros and cons of a UTMA versus a 529?

Again, it’s a matter of flexibility and what the minor’s benefit will be used for. The government regulates what a 529 can be used for; a UTMA can be used on just about anything for the minor pursuant. The tax benefits vary, too — ultimately, it might be worth talking to an accountant at a financial institution to better understand the implications for you and your family on this important decision.

Which reminds us: In a way, it’s not a choice at all, as nothing prevents you from having it both ways. “They are not mutually exclusive,” says Yudina. “You can have both if your financial situation allows.” Suffice it to say that whatever you choose — a 529, a UTMA, or both — setting up an account today for your child’s future is better than doing nothing, whether their first class is this fall, in Fall 2040, or beyond.