529 vs. UTMA/UGMA: What are the differences and which is better?

When considering how to fund a child’s college education, many parents turn to an obvious place, a 529 account. A 529 plan offers tax advantages for saving and the ability to invest in potentially high-return assets. But parents have another option known as UTMA or UGMA accounts, custodial accounts that give minor children the ability to save and invest.

But is a 529 plan better than a UTMA or UGMA account? Here are some key things to know.

529 accounts vs. UTMA/UGMA accounts

Here are some of the key advantages and disadvantages of 529 accounts and the custodial uniform transfer to minors accounts (UTMA) and uniform gift to minors accounts (UGMA).

Pros and cons of 529 accounts

Pros

• Tax-deferred growth. Inside a 529 plan money can grow without paying taxes on it.
• Potentially high-return investments. Money in a 529 can be invested in high-return investments such as stocks and stock funds, allowing the money to grow faster.
• Tax-free withdrawals for education. Withdrawals from the account are tax-free as long as they’re used for qualified educational expenses.
• A plan’s beneficiary can change. If someone else needs to use the plan, the beneficiary can change over time, meaning the plan could work for multiple kids or even an adult who wants to go back to school.
• State tax deduction. Some states offer additional reductions on your state income tax if you put money away in a 529 plan.
• Student loan repayment. A 529 allows funds to be used to repay student loans, up to $10,000 for the beneficiary and up to $10,000 for a beneficiary’s siblings. But check your state’s laws to be sure repayments qualify as tax-free.
• Reduced impact on financial aid. A 529 plan isn’t owned by a child, so this kind of account, if it’s owned by parents, has a lesser effect on financial aid eligibility as measured by the Free Application for Federal Student Aid (FAFSA).
• Rollover to a Roth IRA. The rules around 529 plans changed with the 2022 SECURE Act 2.0. A plan that has been open for at least 15 years can be rolled over into a Roth IRA for the beneficiary, up to $35,000 in a lifetime. The feature doesn’t kick in until 2024.
• More education options. A 529 plan can also be used to pay tuition for private K-12 schools for younger children, as well as apprenticeship programs.

Cons

• Somewhat inflexible. While the beneficiary can be changed over time and any money rolled over into a Roth IRA, you may run into some issues if the money can’t be used. If not, it must be withdrawn and you’ll owe taxes on the earnings, plus a 10 percent penalty.
• Grandparent penalties. A 529 plan owned by grandparents historically hurt a student’s financial aid chances even more than a parent-owned account. However, the rules are changing for the 2024-2025 award period and won’t require grandparents to report their financial assistance.
• Limited spending categories. A 529 plan limits qualified expenses to costs that are very closely tied to education, and even some expenses that may seem like they’re tied to education won’t qualify.

Pros and cons of UTMA/UGMA accounts

Pros

• Flexibility in investments. A custodial account can flexibly invest in high-return assets such as stocks and stock funds with a brokerage or with more traditional assets such as CDs at a bank. A UTMA account can also invest in real estate and other property.
• Lower child tax rates. Moving money to a minor child’s account makes the tax burden on earnings lower than if the money were held with the parent, including some tax-free earnings and a lower initial tax rate.
• Money can be rolled into a 529. A UTMA/UGMA account can still be rolled into a 529 plan later on, if that makes more financial sense.

Cons

• Greater impact on financial aid. Because they’re held in the name of the child, UTMA/UGMA accounts hurt financial aid eligibility more than comparable 529 plans.
• Money becomes the child’s at majority. When the child reaches the age of majority, often 18 or 21 depending on your state, the money becomes theirs, meaning it may not be spent as intended.
• Transfers are irrevocable. Once a transfer is made, it cannot be undone and it belongs to the minor child. Money cannot later be transferred to anyone else.

Which is better?

A 529 account and UTMA/UGMA accounts both offer some distinct advantages, but a 529 plan really provides a lot of extras, though at the cost of some flexibility, which may not always be a bad thing. Besides the pros and cons above, here are how experts view their relative benefits.

529s can offer ease of investing

“State 529 education savings plan accounts typically have simple-to-use, pre-configured ‘year of enrollment’ and ‘target risk’ portfolios that make the investment decision much easier for less experienced investors,” says Stephen Jobe, senior vice president at Vestwell, a savings plan provider.

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529s are more flexible than in the past

“Federal 529 rules continue to evolve and permit more flexibility in the use of funds,” says Jobe.

Some of the 529 plan’s inflexibility has been addressed with recent legislation, letting 529s be used for more educational institutions, debt paydown and even Roth rollovers. These changes better position the 529 against custodial accounts, even though the latter is still more flexible.

A 529 is better for financial aid calculations

And when it comes to being eligible for more financial aid, a 529 plan is the way to go. That’s because a 529 owned by a parent is treated as an asset of the parent for financial aid purposes, while a UTMA/UGMA account is considered an asset of the child.

“Both have an impact on FAFSA,” says Isaac Bradley, J.D., CPA, director of financial planning at Homrich Berg, a wealth manager. “But the parent’s assets generally have less of an impact because parents are expected to contribute a smaller percentage of their assets than the child.”

Bradley explains that assets held in a parent’s name are figured to contribute at up to 5.64 percent, while those held in a child’s name are figured at 20 percent.

A UTMA/UGMA may provide too much flexibility

While the 529 is limited to education, that inflexibility may make it better in some cases. That’s because a UTMA/UGMA account becomes the minor’s at the age of majority. So the money can be used however the adult child sees fit with no restrictions and could be totally wasted.

“If you know funds will be needed for higher education, then a 529 plan is the most tax-efficient and allows the owner to maintain control of the account and make beneficiary changes as desired,” says Bradley.

Other alternatives to a 529 plan

Those looking for other alternatives to a 529 account have a number of them that could work. A Coverdell education savings account could be a good fit for families keeping their contribution to less than $2,000 each year, though a 529 offers more flexibility, says Bradley.

Bottom line

As a specialized account, the 529 account offers a range of extra benefits that a UTMA or UGMA account can’t really offer, while not suffering from some of the same drawbacks. Recent changes to 529 plans have made them more flexible than ever, offering even more use cases.