As a licensed financial advisor, one of the most common questions I get is “What is the best way to invest for my child’s future?” The resulting conversation ordinarily results in the establishment of either a 529 college savings account, a Uniform Gift to Minors Act account (UGMA), or a combination of both.
A UGMA/UTMA account is owned by the child but controlled by the custodian. The funds deposited are gifted irrevocably to the child and cannot be reversed. Taxes are paid on earnings annually with some “Kiddie Tax” benefits. Investment choices are not restricted and the use of funds is not limited. Control of the account shifts to the child when he/she reaches the age of majority. The funds in these accounts can reduce the child’s college financial aide eligibility by up to 20% of the account value. This type of account is also beneficial if used for non-educational expenses.
A 529 account is owned and controlled by the custodian until the child reaches the age of majority. Investment options are more limited and taxes on earnings are deferred until they are withdrawn and are not due if they are used for qualified education expenses. If the funds are withdrawn for nonqualified expenses, they will be taxed at the beneficiary’s tax rate at the time of withdrawal and may be subject to a 10% penalty. If the child decides not to go to college or trade/vocational school, the account can be transferred to another family member. A 529 account is viewed by FAFSA more favorably and will only reduce financial aide eligibility by as low as 5.64% of the account value.
Factors to consider:
1. How certain are you that your child will pursue higher learning or go to private K-12 school? Could another family member benefit by the account should they decide not to go?
2. Are there family members/friends that would be more likely to gift your child money if they know it will be used for their education?
3. Federal grants and loans are available to most students. Scholarships are also offered. There are more and more businesses that offer education benefits to their employees.
4. Do you feel comfortable with your child having control of a UGMA account when they reach the age of majority? Some parents prefer to put funds away in a trust.
5. Some parents find it to be important for their children to be financially responsible for themselves, or are in a position where it is more important for them to contribute to their retirement.
Investing in your child’s future is an important component of a more holistic financial picture. A trusted financial advisor/planner can help you develop a personalized financial strategy.