There's more than one way to save for college. Many parents sock away college funds in tax-advantaged investment accounts called 529 plans, but there are other account options with tax benefits available.
New York City-based financial planner Stacy Francis says the money in accounts called Uniform Gifts to Minors Act or Uniform Transfers to Minors Act accounts can pay for things 529 plan funds aren't eligible for.
A Uniform Gifts to Minors Act or Uniform Transfers to Minors account can be a savings or checking account, mutual fund account or brokerage account, says Thomas Kazmierczak, a 529 plan specialist with financial firm T. Rowe Price. "The main difference between this kind of account and any another account is selecting Uniform Gifts to Minors account or a Uniform Transfers to Minors account on the generic account registration form."
Often, these accounts are referred to as custodial accounts, which means a parent or guardian makes decisions about the account until the child comes of age, generally between 18 and 21, depending on the account and the state.
[Learn what steps to take in choosing age-based 529 plans.]
The main advantage of Uniform Gifts to Minors Act or Uniform Transfers to Minors Act accounts is the ability to save without paying taxes on up to $1,000 in earnings, no matter what the child will eventually use the money for in the future. The next $1,000 dollars is taxed at the child's federal income rate, which is normally lower than what the parents would be taxed, Francis says. If the $1,000 is the child's only income that year, no tax would be charged because the standard deduction would cancel it out, she says.
If a parent contributed $100 per month to the account and the account grew at 5 percent annually, that's nearly $30 of growth the first year, which wouldn't be taxed. If the parent continued to make $100 monthly contributions for five years with annual growth of 5 percent, the annual growth for the fifth year will climb to almost $300.
If the child doesn't earn any other income, the earnings won't get charged taxes potentially for years into the future.
Some parents may want to remain in control of the assets throughout their offspring's college career. If a 529 plan lists the parent as the owner, that parent is always the owner and decision-maker, no matter how old the child or adult gets.
However, with Uniform Gifts to Minors Act and Uniform Transfers to Minors Act accounts, a "downside is at that expiration, the assets belong to the child," says personal financial specialist Lisa Featherngill, managing director of planning for financial firm Abbot Downing.
Depending on an individual state's law, the child who is named as the beneficiary on a Uniform Transfers to Minors Act account gets full control of the funds somewhere between the ages of 21 to 25, though it's 21 in most states.
The Uniform Transfers to Minors Act account allows for more time for children to mature before they are given accounts, Francis says. Uniform Gifts to Minors Act accounts skew even younger: The account holder is generally given full control of all assets in the account at age 18, she says.
Whether a parent should set up a 529 plan account or an Uniform Gifts to Minors Act or Uniform Transfers to Minors Act account depends on whether or not the funds will be used for qualified education expenses. If parents saved in a 529 plan, they could be taxed on the portion of earnings not used for qualified education expenses, such as tuition and textbooks, and pay a 10 percent penalty on the unqualified education expenses withdrawal, Francis says.
"For example, if you contribute $100,000 into a 529 plan and it grows to $110,000 over time and you make an unqualified withdrawal for the entire amount, you are taxed on the $10,000 gain plus a 10 percent penalty on the $10,000," which would be $1,000, Francis says.