Before I had kids I read up on all the types of ways to save for retirement. There were 401Ks, Roth IRAs, traditional IRAs, and personal investment accounts. Now they have even added Roth 401Ks. I have tried to be responsible and make sure I save some for retirement, but I know that I could have done better. I’m still playing catch up now but making big strides.
With that in mind, I started thinking about ways to make sure I would have some savings to help my children. I wanted to start as early as possible to make sure I could maximize the effect of whatever I chose. When researching my options, I discovered a couple of different options that have varying differences.
Education Savings Account (ESA) or Education IRA
A Coverdell Education Savings Account (ESA) is a tax-advantaged investment account that can be used to pay elementary, secondary, or higher education costs. This includes tuition, books, supplies, and uniforms. An ESA has a limit of $2,000 (after tax) per year, per child and income limits for eligibility. One advantage of an ESA is that you won’t have to pay taxes when you withdraw the money to pay for educational expenses. Also to avoid taxes and penalties the beneficiary will need to use the money in the account by the age of 30.
A 529 plan is another investment option to consider especially if you don’t meet the income limits for an ESA. A 529 plan is available in almost every state and is used to save for a college education. When looking into a 529 it is good to choose one that allows you to choose the funds you invest in. Most states allow you to choose between two or three investing portfolios. You can reallocate the money within the portfolio you choose, but only twice a year. A 529 plan also allows you to change the beneficiary to another family member if needed. This is great in instances where one of your kids decides not to go to college.
Unlike an ESA, a 529 plan does not have an age limit to use the money but withdrawals for college expenses are still tax-free. Contribution limits are currently at $14,000 per year. Some 529 programs also have lifetime limits, but those vary from program to program.
Custodial Investment Account (UTMA or UGMA)
Custodial investment accounts are a more flexible option than the previously mentioned savings and investment options for your child’s future. Also known as Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), gives you a full range of investment choices as well as the ability to use the funds for any use. With these custodial accounts, all funds in the account are considered a permanent gift. The beneficiary gets full control when they reach the vesting age which is normally 18 or 21. These types of custodial accounts are very similar but have two main differences.
The type of assets allowed in the account makes up the main difference between these two types of custodial accounts. A UGMA account is limited to purely financial products such as cash, stocks, mutual funds, bonds, other securitized instruments, and insurance policies. A UTMA account, on the other hand, can hold any form of property, including real property and real estate. A parent could put their car into a UTMA account if they so choose, or the deed to a family home.
The next big difference is related to availability. Being older, all states have adopted the UGMA custodial accounts. Not all states allow UTMA accounts. So you should check with your local state laws to see which ones are available to you.
Looking at all the benefits and cons of each type of account, I decided to go with the UTMA custodial account. I liked the flexibility of fund usage. In addition, I also liked having a full range of investment options. For now, I will try to maintain the account myself, but you can also hire a professional to manage the account. Hoping this will give my child a great jumpstart as they become an adult.