By Zack Taylor, Associate
Most parents would aspire to give their children a better future than they had for themselves growing up. A better future can mean many different things but setting them up to be able to take on the world from a position of financial strength when entering adulthood is a common desire for many parents. The question is, what is the best way to go about doing this? While setting money aside in a savings account is something that would come to mind, it may not be the most effective way to reach these goals for your children. In the following paragraphs, we will cover a few ways to help your child down the line whether it be for educational needs or anything else life throws at us in adulthood.
529 Educational Savings Plan
529 plans were originally set up to help parents set funds aside for their child’s post-secondary education costs (college). Since their creation, there have been a few changes made. They are now able to help cover the costs of K-12 education if the child will be attending private school or different apprenticeship programs. Additionally, they have been adjusted to where they can be used to pay off student loans, or if never used, be transferred to fund an IRA.
Benefits of using a 529 plan:
- Firstly, the money that funds these investment accounts grows tax deferred and as long as the funds are used for educational purposes, they can be withdrawn tax free.
- 529’s provide high contribution limits. In 2024, $18,000 per parent can be contributed to these accounts without going over the annual gift tax exclusion. However, each state has a different contribution limit for each 529 account, typically totaling between $235,000 and $550,000.
- State rules vary, however, depending on the state where the 529 is set up, contributions may be tax deductible.
- 529’s can be transferred once per year to different family members to include sons, daughters, stepchild, foster child, adopted child, brother, sister, stepbrother, or stepsister, in-laws, and cousins.
- If 529 funds are not used for educational purposes, the funds can be transferred to a Roth IRA. The maximum lifetime limit for these transfers is $35,000 per beneficiary.
Downsides of using a 529 plan:
- Depending on the state, oftentimes, 529 plans have a very limited pool of investments that these funds can be invested in.
- If these funds are taken out as non-qualified withdrawals (not for educational purposes) they will be subject to income tax as well as a 10% penalty similar to IRA/401(k) penalties.
- Additionally, having funds set aside for education purposes can have an impact on the financial aid received for higher ed programs.
Uniform Transfers to Minors Act (UTMA)
Another avenue parents can consider when thinking about setting funds aside for their children is by using a UTMA account. These types of accounts offer more flexibility than a 529 plan which some will find to be more attractive. Depending on the goals of the parents and where they see their children down the line, it may be a more fitting solution. Established in 1986, The original purpose of UTMA is to provide a legal framework for adults to transfer assets to minors without the need to establish a trust. However, since then, they have been used as a tool to help prepare a child for their future.
Benefits of an UTMA account:
- UTMA’s are different in that there are no contribution limits for these accounts. Therefore, individuals can put as much as they see fit into this type of account, however, they are still subject to the gift tax restrictions.
- The biggest benefit to a UTMA is that there are no restrictions on how the funds are spent as long as they are used for the benefit of the child.
- While the tax benefits aren’t as good as a 529 plan, income generated from the investments are taxed at the child’s tax rate which will more often than not be lower than the parents.
- Assets remain in control of the custodian (parents) until the minor reaches the age of majority. In most states that is between the ages of 18-21. At that time, the account transfers fully into the minors name.
Downsides of an UTMA account:
- A potential downside that goes hand in hand with the upside mentioned above is the transfer of control. These accounts require the funds to be transferred at a certain age and the custodian loses control. If you were to have an irresponsible adult child, this could be more problematic than helpful.
- For higher education purposes, assets held in a UTMA account are considered the student’s assets for financial aid applications. This can have a significant impact on eligibility for need-based financial aid.
- The tax benefits involved with these accounts are quite limited compared to other options.
Conclusion
If setting funds aside for your children is a goal, taking the time to consider which accounts will be most effective to do so will make a big difference in how much they will receive when the time comes to use the funds. Perhaps you don’t believe college isn’t part of your children’s path. Maybe you want to help with a home downpayment in the future. Whatever the reason may be, setting money aside for them will help to give a head start in life when that time comes. If you have questions about your specific situation, reach out to us at Harris Financial Advisors and we can help decide what will be the best decision for you and your children’s futures!
