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UGMA/UTMA or 529 Plan: Efficient Legacy Planning

UGMA/UTMA or 529 Plan: Efficient Legacy Planning

March 01, 2024

UGMA/UTMA or 529 Plan: Efficient Legacy Planning

 

Introduction

Many of us get excited at the thought of saving money for the purpose of gifting to the next generation and luckily there are some accounts that are tailored specifically to accomplish this goal. UGMA/UTMA’s and 529 Plans are both tailored specifically to meeting your needs when it comes to funding the lifestyle of children or grandchildren. These accounts can be very effective but have some downfalls if the proper care is not taken in selecting the right account. Let’s dive into the details…

 

What is an UGMA/UTMA

UGMA/UTMA accounts are called custodial accounts, and their names are an acronym for “Uniform Gift to Minor Account” and “Uniform Transfer to Minor Account”. These accounts are a way for a parent, guardian, or other family member to begin saving money for a minor while reaping some tax benefits. These accounts are counted for tax purposes as the child’s asset and thus every dollar deposited in the account will count as a gift to the minor. This means that if you contribute more than $18,000 ($36,000 for a married couple) you will trigger a gift tax. Additionally, because it is counted as the minor’s asset, it can decrease their student loan eligibility by up to 20% of the account1.

Taxation of UGMA/UTMAs

Although UGMA/UTMAs are funded using after-tax dollars, they do have some tax benefits. In 2024, the first $1,250 of income that the account generates (non-qualified dividends, Interest) is tax free. The next $1,250 is taxable at the child’s tax rate and any amount more than that cumulative $2,500 is taxed at the custodian’s tax rate2. For example, if an UGMA/UTMA you opened for your son has income from $3,000 of income on the account (non-qualified dividends and interest). Of that $3,000, $1,250 would not be taxable, $1,250 would be taxable at the minor’s tax rate (probably 10%) and the remaining $500 would be taxed at the parent’s tax rate.

Cautions About UGMA/UTMAs

One caution to have about UGMA/UTMAs is that the minor has access to the funds as soon as they reach their states age of majority, typically between 18 and 25 depending on the state. This can be a real detractor for many people who fear their children may not have the maturity to responsibly use the money at that age3.

What is a 529 Plan?

A 529 plan is a qualified account that is used to fund college or other forms of education. 529 plans are funded using after-tax dollars that grow tax free and can be withdrawn tax free for qualified education expenses which can include more than just tuition. Another major note of 529 plans is that the person who opened the account remains the owner of the account and thus remains in control of the account.

Taxation of 529 Plans

A 529 plan grows completely tax free, and distributions are tax free as long as they are used for qualified education expenses. If not used for qualified education expenses they will trigger a 10 percent penalty. A new rule that came into effect this year allows you to convert up to $35,000 of a 529 plan into a Roth IRA without paying taxes or the penalty (Subject to IRA contribution limits)4. Keep in mind that if you give over the amount of the annual gift tax deduction to one beneficiary you will be subject to gift taxes.

Cautions About 529 Plans

The biggest precaution to take when it comes to 529 plans is that if they are used for anything other than school, they will incur both taxes AND a 10% penalty. The only exception to this is rolling up to $35,000 annually over to a Roth-IRA. Therefore, it is not recommended that these accounts be opened unless there is a high probability that the beneficiary will use it for education.

A Note on Trusts

Another option for passing wealth through the generations is using trusts. Trusts are typically best when you have larger amounts that you wish to pass on or more complex desires to be fulfilled. Trusts tend to cost more to open because of attorney fees, but also have significantly more flexibility to mold to your wishes. However, with their complexity, trusts can work improperly if you don’t get a solid attorney. You may want to speak to your advisor to see if a trust is the right option for you.

Concluding Thoughts

In the end, each person’s situation is different and should be considered carefully. Please contact a professional for more clarity before making any major decisions. We would be happy to answer any questions. Please email us at cornerstone.service@oneascent.com

 

 

 

 



Endnotes

1Kuchar, K. (2023, November 10). What is an UTMA or UGMA account?. Savingforcollege.com. https://www.savingforcollege.com/article/what-is-an-ugma-or-utma-account#:~:text=UTMA%20stands%20for%20Uniform%20Transfers,estate%20and%20other%20tangible%20assets.

2Viewpoints, F. (2024, January 31). Ugma & Utma Accounts: Tips for Custodial Accounts. https://www.fidelity.com/learning-center/personal-finance/custodial-account-for-kids#:~:text=A%20portion%20(up%20to%20%241%2C250,than%20the%20parent’s%20tax%20rate.

3Age of majority and trust termination. Finaid. (2024, February 15). https://finaid.org/savings/ageofmajority/

4Taylor, M. (n.d.). Can I avoid the 529 plan withdrawal penalty?. Bankrate. https://www.bankrate.com/loans/student-loans/no-escape-from-529-plan-penalty/#rules

 

  

OneAscent Financial Services, LLC (“OAFS”), d/b/a The Cornerstone Financial Group, is a registered investment adviser with the United States Securities and Exchange Commission. OAFS does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by OAFS or any unaffiliated third party. OAFS is neither an attorney nor accountant, and no portion of the presented content should be interpreted as legal, accounting, or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly