College Savings Options

"We believe, that is, you and I, that education is not an expense. We believe it is an investment."

- Lyndon B. Johnson, October 16, 1968


Welcome to Part II of our series on education planning! Last week we focused on some general tips to keep in mind as you strategize your college planning. Today we will look at a few specific saving plans in order to help you determine which option is right for you and your family.

As you prepare to create a college saving plan, the amount of information and variety of options can be overwhelming. We’ve concentrated on a few of the more popular plans: today we will examine 529 Plans, Coverdell accounts, and UGMA/UTMA accounts.

529 Plans

What is it? A 529 Plan (which gets its name from section 529 of the Federal Tax Code), is a savings plan operated by a state or educational institution with tax advantages in order to make saving for college easier (definition via There are two types of 529 plans: College Savings, and Prepaid Tuition. The College Savings Plan operates somewhat similarly to an individual investment account. The account owner can create a portfolio, and gain and lose money based on that portfolio. In a prepaid tuition plan, you purchase tuition credits, which are based on current tuition inflation (in other words, you are paying future tuition prices in today’s dollars).

Why it’s a good option: Earnings in 529 plans aren’t subject to federal tax (or often state tax). Some plans accept up to $300,000 in maximum lifetime contributions, and these funds can be used for tuition, fees, room and board, books, and equipment at any accredited college in the United States or abroad, so it has a broad spectrum of application. While most states offer 529 plans, you aren’t required to accept one’s state plan because you live there. In fact, you may be able to have a California 529 plan while living in Tennessee, while your child attends school in Maine.

Who it’s best for: Anyone over the age of 18 can set up a 529 plan, so it can be a good option for relatives who may want to create a savings plan for their grandchildren, nieces, or nephews. It’s also a possible solution for people over 18 who want to save money to further their education.

What are the Buts? Since there is no guaranteed minimum rate of return on 529 savings plans, it’s possible for you to lose money on these plans, and there is a limited ability to change the investment options on an existing plan that isn’t making what you hoped. In addition, any nonqualified withdrawals (i.e. a withdrawal used for something other than the beneficiary’s qualified education expenses) then the withdrawal will not only be taxed at the rate of the person who receives the distribution (often whoever owns the account) but the earnings portion of the withdrawal will be subject to a 10% penalty. There is also a fee associated with opening and maintaining a 529 plan, including enrollment, maintenance, and administration/management fees and expenses*. For 529 prepaid tuition plans, credits are often limited to in-state, public universities, and beneficiaries must often be a resident of the state where they are attending college.

*The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. By investing in a plan outside your state of residence, you may lose any tax benefits.

Coverdell Savings Accounts

What is it? A Coverdell Savings Account is a tax-advantaged savings option that is established for a child under 18 (does not apply for a child with special needs).  Contributions of up to $2,000 can be made to each account each year, and the child for which the account is created does not need to be your dependent.


Who it’s best for: Coverdell Accounts can only be created and contributed to for beneficiaries under the age of 18, so it’s popular with parents and grandparents who may want to start an early college savings plan for their young children. Because of income restrictions (in order to contribute to a Coverdell savings account, you must have a modified adjusted gross income of under $95,000 a year), this can also be a good option if your income is within the limits. Keep in mind that the max contribution to a Coverdell account per year is $2,000, so that may also affect your decision to open one of these accounts.

Why it’s a good option: One of the great things about Coverdell savings accounts is that the funds can be rolled over to another Coverdell account. So if you have multiple children attending college, you may wish to roll funds from this account into either another Coverdell account.  Additionally, all distributions that are used for qualified tuition expenses are tax-free. Contributions to Coverdell accounts are discretionary, so you can contribute what or when you can. Unlike most 529 plans, you also have control over the underlying investments in a Coverdell savings account.

What are the Buts? Funds in a Coverdell must be distributed by age 30, although the rollover properties mean that any undistributed funds can be simply put into another account for another child. Contributions are not tax deductible, so contributions are made with after-tax dollars. There are also the contribution and income restrictions mentioned above, which can have an impact if you want to contribute more than the allowable limit, or if you are contributing to an existing account that someone else is contributing to (for example, if a grandparent opens a Coverdell account and contributes $1,900 in one year, you would only be allowed to contribute $100 to the account that year).

UTMA/UGMA Accounts

What is it? UTMA/UGMA accounts are custodial accounts that are established for minor children under a state’s uniform transfers to minors act, or uniform gifts to minors act (abbreviated UTMA and UGMA, respectively). UGMA accounts authorize cash, bank accounts, stocks, bonds, and mutual funds, and usually terminate at age 18, while UTMA accounts include alternate holdings like real estate and limited partnership interests, and usually terminate at 21 or 25. Depending on the type of account, the child will receive sole control of the money in the account at either age 18, 21, or 25. Additionally, the taxes earned on the accounts are taxed to the child, rather than the custodian.

Who it’s best for: UTMA and UGMA accounts are fairly versatile- there’s no limit for who can contribute to them, and there is no limit on how much can be contributed to the account. However, some investors prefer to keep their annual contributions at or below $14,000 (the annual gift tax exclusion limit). So if you or a relative is looking to contribute a large sum of money to a child’s education, a UGMA or UTMA may be a good bet.

Why it’s a good option: In addition to the lack of contribution restrictions, setting up and maintaining an UTMA or UGMA is fairly easy. Accounts can be opened at your local bank, and unlike a regular trust, you don’t have to prepare a tax return for the account (although you may have to prepare one for the child if the reportable income on the account is high enough). You can also save a bit by avoiding custodian and trustee fees. Because of the way the account is taxed, the first $1,050 of on unearned income is tax-free, and the next $1,050 is taxed at the child’s rate (which is usually significantly less than your rate).

What are the Buts: UTMA and UGMA accounts can be somewhat inflexible- because the account is governed by state statutes, you cannot customize the account the way you can with a trust or one of the accounts mentioned earlier. With an UTMA or UGMA, the child gains sole control of the account at either18, 21, or 25, so if you have concerns about your child’s ability to responsibly manage his or her assets at those ages, you may want to consider alternate savings options. Additionally, the money in an UTMA or UGMA account doesn’t have to be used for college expenses, which can be difficult if the custodian who establishes the account would like the earnings to go specifically to college expenses. However, some children do well with UGMA or UTMA accounts, and have no problem allotting the money to their college expenses. The other downside of an UTMA or UGMA is that because it is taxed to the child, he or she may not be eligible for financial aid.

We hope that the above have helped you to gain a better understanding of college savings plans, and to get a sense of which may be right for you or your family. If you have questions, feel free to contact us. We’d love to answer your questions!