UGMA, UTMA, and the Coverdell ESA

There are two other vehicles for college savings. Neither one is much worth worrying about for most Americans. However, since I am on the subject, I feel obliged to cover my topic.

Coverdell ESA

The Coverdell Education Savings Account (ESA) is nothing more than an IRA applied to educational expenses. As an idea, it is simple, straightforward, and easy to understand. You (the donor) put the money in the account for the child (beneficiary), the money grows tax free. It can then be used for just about any education expenses, including elementary or secondary schools.

With the Coverdell ESA you are not limited to state plans. You can select the brokerage firm you want and you can select the investments you want to include in that portfolio. As with the 529 the money belongs to donor until it is spent by the beneficiary. In emergencies you can get at your money after paying taxes and penalties.

So what’s not to like? The Coverdell ESA is limited to $2,000 per year per child. That is not enough over 18 years to fund one year at a private university, unless you happen to buy the next Apple as an IPO. The Coverdell ESA has been overtaken by events.

Too bad. I like the simplicity and flexibility of these accounts a lot more than the 529.

UGMA and UTMA

The Uniform Gifts to Minors Act (UGMA) has been replaced in most states by the Uniform Transfers to Minors Act (UTMA) which is basically the same thing. As far as I can tell it is primarily a tax loophole for the wealthy. Up to $14,000 a year can be put aside for a child without setting up a formal trust fund. On this point, the UGMA can allow higher contribution rates within certain limitations than the UTMA.

Like a trust, the money no longer belongs to the parent. The money is held in trust by a custodian (usually the parent) for the benefit of the child. If the parent dies while serving as custodian, the UGMA/UTMA will be considered part of the parent’s estate for tax purposes. Until the child reaches the legal age of maturity in that state (18 or 21), any income from account is taxed at the child’s income tax rate rather than the parent’s rate. If the child is still legally a dependent after the age of 19 or 24 depending on the circumstances, the so called Kiddie Tax Law kicks in; charging a higher tax rate.

On things like the UTMA be sure to visit your lawyer and CPA, before making any decisions.

Once the child reaches the legal age of maturity in that state, the money belongs to the child, period. There are no statutory limitations on that money. The child can choose to use it for anything.