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While college costs can seem daunting, TAP 529 makes it easy to set savings goals and establish a strategy to suit your investment needs. 529 Plans have important advantages over other popular college savings vehicles. Below is an example of how three college savings vehicles compare.
529 plans
529 plans get their name from Section 529 of the Internal Revenue Code. Basically, 529 plans work for college savings much like retirement savings vehicles, such as 401(k) plans, do for retirement savings. The money invested in a 529 plan will grow tax-deferred, which means that no taxes are taken out while the money remains in the account. And due to recent legislation, withdrawals taken out for educational purposes will be tax-free.
Coverdell Education Savings Accounts
Coverdell Education Savings Accounts (previously known as Education IRAs) work in a similar fashion. However, unlike a 529 plan, there are income restrictions for opening an account. Also, annual contributions are restricted to $2,000 per child. 529 plans do not have an annual contribution limits (529 plans do have a total contribution limit, currently $315,000 for TAP 529).
Many people can open a Coverdell for a child — a parent, a grandparent, or even a neighbor, and a child may be the beneficiary of more than one Coverdell account. However, annual aggregate contributions to all accounts cannot exceed the $2,000 limit. No contributions can be made after the child reaches 18 years of age, and the account must be used before the child turns 30. There are no such age restrictions on TAP 529 accounts. Like the 529 plans, Coverdell earnings grow tax-free and there are no taxes on qualified withdrawals.
Unlike 529 Plans, Coverdells can also be used for primary and secondary school expenses.
UGMA/UTMA
UGMA/UTMA stands for Uniform Gifts to Minors Act and Uniform Transfers to Minors Act. They are laws passed by each state, which vary somewhat from state to state. Generally, these allow a gift to minors without having to set up a special trust. Instead, the gift is set up in an UGMA/UTMA account that has a designated adult custodian. The account is owned by the child but is controlled by the custodian until the minor reaches a designated age (21 in Pennsylvania). At that point, the child has a legal right to spend the money however he or she wishes.
In a 529 Plan, the Account Owner retains complete control of the account, regardless of the age of the Beneficiary. Because the UGMA/UTMA account is owned by the child, the custodian cannot substitute a different child as the "Beneficiary" of the account. In a 529 Plan, the account owner can change beneficiaries. In a 529 Plan, the Account Owner can use the money in the account (subject to tax penalties); money in an UGMA/UTMA account can only be used for the Beneficiary's benefit.
The UGMA/UTMA provides a way for minors to own securities. Contributions not exceeding $12,000 per year do not create gift tax implications. But gifts made to UGMA/UTMA accounts cannot take advantage of the federal provision, applicable only to 529 Plans, that allows gifts over $12,000 to be prorated over five years. Additionally, in contrast to 529 plans, UGMA/UTMA earnings may be subject to taxation annually, depending on the type of underlying investment.
*These numbers represent Modified Adjusted Gross Income (MAGI). The $2,000 minimum is reduced as MAGI increases from $90,000 or $95,000 as applicable.
1If transfer is made under the special five-year proration rule and the Account Owner dies during the five-year period, a portion of the contribution may revert to the Account Owner's estate.
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