This article was written for educational purposes in 2019. Although it has been updated, certain references or other information may be outdated. This is not intended to be financial advice. Check with your financial advisor, attorney or tax professional about how these concepts might apply to your unique circumstances.
Gifting to the Grandkids
UTMA/UGMA or 529 Plan ... Which Is Better?
Grandparents who want to give money to their grandchildren have many choices, each with slightly different benefits and limitations. Choosing which is best for you depends on your objectives. Before we get into the details, let’s start with why gifting to your heirs benefits you.
Many wealthy, multi-generational families spend decades perfecting their estate plans to leave assets to their adult children and grandchildren. Considerably less time and resources are dedicated to preparing their heirs to receive that inheritance.
Some wealthy parents communicate little to their heirs until the last moment, leave remaining assets in trust and expect the trustees to educate the beneficiaries. This approach — while simple — deprives heirs of financial decision-making knowledge.
A better technique is to trust heirs with ever-increasing amounts of money. Start young and start small. Anticipate the likelihood that they will make mistakes from which they can learn valuable life lessons. Through this, they may gain financial literacy, including budgeting, investing and estate planning tools for their own assets.
UTMAs and UGMAs
(Pronounced UHT-mah and UHG-mah)
Uniform Transfers for Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts are basic trusts for minors that are commonly recognized by banks and brokerage firms. They enable a parent or grandparent to transfer assets to a child under 18 years old (or 21 years old in some states) without an attorney or lengthy trust documents.
U.S. banks will not accept an account from a minor without an adult joint owner or custodian, because without a cosigner, the signature of a minor on a contract is not legally binding. Therefore, if a minor needs an investment account, an UTMA or UGMA account may be a simple solution.
UTMAs and UGMAs are very similar, although the types of assets these accounts can hold differs slightly. UTMAs can hold almost any kind of asset, including real estate. UGMAs typically hold stocks, bonds, mutual funds and insurance policies. Regulations vary by state.
Pros and Cons
- The gift giver can move larger amounts of assets out of their estate
- No limitation on how the gift is used as long as it benefits the child
- A child reaching the age of majority be-comes full owner of the account
- Contributions are irrevocable
- Financial Aid for higher education may be negatively impacted
- Income, capital gains and distributions are federal income tax free
- Qualified educational expenses may include elementary, secondary, private or religious school up to $10,000/student each year
- Owner maintains control and contributions are revocable
- Beneficiaries may be any age
- Distributions not used for qualified educational expenses may be taxable and subject to a 10% penalty
- Over-funding may occur, although these may be transferred to other family members
- State income tax deductions are limited and vary by state
Assets in an UTMA/UGMA can be spent on almost anything, provided it directly benefits the minor. College education? Yes. Car? Yes. Rent? Yes.
Can the custodian use it to pay for family groceries or a family vacation? Probably not. These assets must be exclusively for the minor child. In addition, these assets should not be spent on expenses that are typically the responsibility of the parent. If a child has a broken leg, the cost of medical care would typically be paid by the parents, so these medical bills would likely not be a legitimate UTMA/UGMA expense.
These are hypothetical examples. For advice about specific situations, consult an estate attorney.
One factor is certain: When the minor reaches the age of majority (age 18 or 21, varies by state) the money is theirs, and the custodian has no further control of it. Financial knowledge learned from grandparents and parents could be a great asset.
529 Plans for Educational Savings
A 529 plan is meant specifically for paying higher education expenses. This college savings tool has been available nationally since 1996 (and in Michigan since 1986).
Unlike UTMA/UGMA accounts, 529 plans offer significant tax benefits. In general, the income and capital gains in a 529 plan do not get taxed federally.
Not all 529 plans are created equal. Each state has slightly different programs, benefits and investment alternatives. More than half of the states offer a state income tax benefit to encourage college savings.
Many banks and brokers offer their own 529 plans, although these plans may not have the same benefits as state-run 529 plans.
Assets in these plans must be used for qualified educational expenses, which include tuition, fees, books, computers, supplies, and possibly room and board. Some limitations apply. Health insurance, transportation to and from campus, college application fees, and student loan payments are not eligible expenses.
Like UTMA/UGMA accounts, a 529 plan has an owner and a beneficiary, but in this case the owner is permanent. A minor beneficiary does not get possession of these assets on becoming an adult.
The owner is responsible for administrative duties. So even if Grandma funds the 529 plan, she may be wise to identify her grandchild’s parent as the owner, or else Grandma will be responsible for the record-keeping and check-writing.
And the Winner Is …
The best UTMA/UGMA or 529 plan for you and your heirs depends on how much you plan to give, whether the tax benefits are important to you, the projected cost of education, etc.
Tax benefits make 529 plans very appealing, especially for smaller gifts. Conifer Bay Capital believes that most families would benefit from at least a small amount of savings in a 529 plan. Even in situations where scholarships cover tuition, other expenses could be met with 529 plan assets.
However, 529 plans make less sense for larger gifts from one source. Illinois, for example, only allows a state income tax deduction of $10,000 per individual taxpayer. If Grandma has four grandchildren and wants to utilize her entire $15,000 annual gift tax exclusion for each grandchild, only $10,000 will be a valid Illinois income tax deduction. The remaining $50,000 will receive no Illinois state tax benefit for the contribution.
Consider a wealthy family with 10 grandchildren, and both grandparents plan to take advantage of the entire $15,000 annual gift exclusion to remove $300,000 from their estate. The Illinois 529 plan allows a state income tax deduction for only the first $20,000 while the remaining $280,000 —whether UTMA/UGMA or 529 Plan — would not.
The fact that 529 plans are less advantageous for wealthier families demonstrates that these regulations were crafted to be slightly progressive, helping middle-income families more than the Top 1%.
For advice on whether UTMA/UGMA accounts or 529 plans make sense for your family, please contact Mary Samuelson. With additional information about your goals and gifting capacity, she can provide input to help you decide which approach is better for your circumstances.