Insights

Saving for Education: 529 Plans, Roth IRAs, & UTMA

12.05.23

Because the cost of education is growing faster than the rate of inflation, saving for education has become an essential part of a financial plan. While there are several options available when considering saving for education, every family’s situation is unique and needs to be carefully considered when planning for the future.  

529 Plans

529 plans are tax-advantaged education vehicles that are governed by federal law but run by states through designated financial institutions that manage and administer specific plans. As with anything else, there are advantages and disadvantages to using a 529 plan, such as:

Advantages Details
Tax Benefits529 investments grow on a tax-deferred basis and distributions are tax-free when used to pay for qualified education expenses. In 2024, beneficiaries of these plans will be able to rollover up to $35,000 tax-free into a Roth IRA (subject to certain limitations). Most states exclude these plan distributions from taxable income and many offer a state income tax deduction or state income tax credit.
Low Maintenance529 plans can be opened online or through a licensed financial advisor and can even be set to an automated investment plan, with a program manager handling ongoing investment management.
High Contribution Limits529 plans have no annual contribution limits and high aggregate limits. Contributions to these plans are considered to be completed gifts to the designated beneficiary for tax purposes.
Favorable Financial Aid TreatmentThese plans typically have a relatively minimal effect on financial aid eligibility.
Flexibility Benefits of these plans are the same for all families, regardless of income or contribution amounts.
Disadvantages Details
Non-Qualified Withdrawal PenaltiesNon-qualified distributions are subject to income tax AND a 10% penalty on the earnings portion. But there are exceptions if the beneficiary earns a scholarship, attends a US Military Academy, dies, or becomes disabled.
State Income Tax RecaptureIf an account owner does a rollover into another state’s 529, any state income tax deductions and credits previously claimed may be subject to recapture. The earnings portion of the outbound rollover may be added back to state taxable income.
Limited Investment ChoicesAn account owner must choose from a menu of investment options.
FeesExpenses vary among 529 plan portfolios, so it is important to research options and find a low-cost option that meets a family’s needs.
Ownership RulesThe account owner holds legal control over the money in the account and can easily change the beneficiary at any time. Or, they can take a non-qualified distribution and liquidate the plan.

When deciding if a 529 plan if right for you and your family, ask yourself:  

  1. Will you be using these funds exclusively for education purposes?
  2. How much do you need to save for school, from pre-school to post-secondary education?
  3. What state do you live in and what are the rules and regulations?

Roth IRAs

A Roth IRA is an individual retirement account used to save for retirement. But, you can tap into your Roth to pay for college costs if you follow certain guidelines.

What are the guidelines?

You can withdraw your original contributions to a Roth IRA at any time without triggering a tax penalty, and qualified distributions are tax and penalty free. While withdrawing funds before the age of 59 ½ is considered a non-qualified distribution, there are exceptions that include paying for qualified higher education expenses. The distribution cannot exceed the education expenses and must be paid to an eligible educational institution.

What else should you know?

Withdrawing your original contributions or account earnings without a tax penalty is a more attractive option than taking out student loans. Also, new contributions continue to grow even if you use a portion of the funds for college. But, you are removing money from your retirement nest egg, which can deeply impact your future. You can read more about Roth IRAs here.

UTMA/UGMA

Custodial accounts under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) are accounts created under a state’s law to hold gifts or transfers that a minor has received. The accounts are managed by a custodian, and once a gift or transfer is made to an account, the gift or transfer cannot be revoked. Because the minor owns the assets in the account, the account is held and reported under the minor’s Social Security number (SSN).

Roth IRAs for Minors

Also known as Custodial IRAs, Roth IRAs for Minors are tax-advantaged retirements accounts that are owned by a minor but controlled and funded by an adult custodian until the minor reaches legal adulthood. Because the accounts are intended for children, there is some flexibility. For example, contributions can be withdrawn tax and penalty-free at any time. Some basic rules to know: There is no age limit. The child must have earned income. And there are contribution limits.

Comparing Your Options

Every family’s situation is unique, which is why selecting the best plan or combination of plans can be extremely challenging. The chart below demonstrations the differences among the plans.

529 PlanRoth IRAUTMARoth IRA for Kids
Annual Contribution$17,000 per beneficiary/per year/per contributor. “Superfunding” is allowed with up to 5 years worth of contributions in a single year ($17,000 x 5 = $85,000)$6,500/year ($7,500 after age 50), or annual earned income amount, whichever is lessNone$6,500/year, or annual earned income amount, whichever is less
Earned Income CapNone$153,000 for single filers; $228,000 for married couple filing jointlyNoneSame as those for Roth IRAs
Aggregate Contributions LimitVaries by state between $235,000 – $550,000NANANA
State Income Tax benefitsOver 30 states plus DC allow state income tax deductions or tax credits on contributionsNoneNoneNone
Third party contributionsAllowedNot AllowedNot AllowedNot Allowed
Investment OptionsPre-built static or dynamic portfoliosBroad set of investments, including stocks, bonds, ETFs, mutual fundsBroad set of investments, including stocks, bonds, ETFs, mutual fundsBroad set of investments, including stocks, bonds, ETFs, mutual funds
Control of Investment OptionsNoYesYesYes
Financial aid impact (Assets)Balance is reported as an asset on FAFSA application and may
 reduce financial aid eligibility by 5.64% of the asset value if owned
 by a dependent student or a parent.
Not reported as an asset on the FAFSAReported as a student assetNot reported as an asset on the FAFSA
Financial aid impact (Income)Beginning December 2023, distributions will not be counted as income if the account is not owned by a parent or studentDistributions are reported as taxable or untaxed income on the FAFSADistributions are reported as income
on the FAFSA
Distributions are reported as taxable or untaxed income on the FAFSA
Withdrawal RestrictionsTax-free at any time and proceeds are used for qualified education
expenses
The principal portion can be withdrawn tax- and penalty-free at ay time. Earnings portion can be withdrawn after age 59 1/2 tax- and penalty-free. 10%-penalty will be assessed on premature withdrawals.With the consent from an adult custodian or upon reaching the age of
which varies in each state
The principal portion can be withdrawn tax- and penalty-free at ay time. Earnings portion can be withdrawn after age 59 1/2 tax- and penalty-free. 10%-penalty will be assessed on premature withdrawals.
Who can openAnyone of age can open and fundAnyone of age who has earned incomeAnyone of age can open and fundParents of the minor child, who has earned income; the child owns the account

Schedule a meeting with your MAI Wealth Advisor to discuss the best strategies that will benefit you.


Information as of November 30, 2023.

The opinions and analyses expressed herein are subject to change at any time. Any suggestions contained herein are general, and do not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Distribution hereof does not constitute legal, tax, accounting, investment, or other professional advice. Recipients should consult their professional advisors prior to acting on the information set forth herein. In accordance with certain Treasury Regulations, we inform you that any federal tax conclusions set forth in this communication, were not intended or written to be used, and cannot be used by any taxpayer, for the purposes of avoiding penalties that may be imposed by the Internal Revenue Service.

We look forward to learning about your financial goals.

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