In a previous article “Are 529 Plan Tax Benefits Really Worth It?” we discussed the 529 Plans and their benefits. The benefits of a 529 savings plan are as follows:
- Control of the money by the contributor as owner of the account. Allows owner to direct how money is invested (however you need to account for the risk).
- Can dictate who the beneficiary is of the 529 college savings plan and what assets are used for. Allows the owner to change the beneficiary to other children if one of your children doesn’t need the money.
- When 529 plan funds are used for qualified college expense there are no taxes due on the gains.
The UTMA or UGMA alternative.
One alternative to 529 plans is the UTMA or UGMA account. UTMA stands for Uniform Transfer to Minors Act. UGMA stands for Uniform Gift to Minors Act. This type of strategy saves taxes only to the extent that any taxable gains on the account are taxed at the minor’s lower tax bracket. So if the parent is in a 30% tax bracket and the child is at 10%, you would save 20% in taxes. The control issue seems to be the big drawback to UTMAs and UGMAs. As soon as the minor is considered legal age (18 in most states), the minor now controls the money and could spend it on anything he or she wants. However the greater reason why parents should not use UTMAs or UGMAs is the potential reduction in “need based” aid available to your college student. The asset value in UTMAs or UGMAs would be reported as owned by the student on the FAFSA (Free Application for Federal Student Aid) and would reduce the potential aid by 20% of the value of the account. In other words, if your child (minor) had $20,000 in a UTMA or UGMA, their potential “needs based” aid would be reduced by $4,000.
The Best Alternative to 529 College Plans
If you are serious about getting the best bang for your college buck, parents should vigorously explore the purchase of an Indexed or Fixed Universal Life Insurance policy. This alternative would provide for the following benefits (if structured appropriately:
- Control of the money. The owner of the policy should be the parent of the college student.
- Control of the money spent for college. The owner dictates how the cash value of the life policy is invested and spent. No need to determine which of your children are going to need the most help from mom and dad.
- Use of the cash value as needed can be structured wherein there is no tax on the gains on the cash value in the policy.
- The death benefit is an additional benefit itself. If the unfortunate and unforeseen should happen to the bread winner (mom or dad or both) the death benefit (non-taxable) would be the means by which college funding could be accomplished. It also is the means for income replacement to any survivors named as the death benefit beneficiaries.
- The remaining unused cash value can be used for retirement income, also on a tax free basis. The other alternatives do not have this benefit.
The Indexed or Fixed Universal Life policy at inception needs to be structured wherein it is a Non-MEC or not a Modified Endowment contract. A non-MEC contract allows for the use of the cash value on a tax favorable basis versus one that would be a MEC policy. It should also be purchased where the death benefit amount is at the least possible amount preserving its non-MEC status. Doing so would create for the greatest amount of internal buildup of the cash value which is the primary goal of the policy.
So for comparison purposes, see the following graph:
|529 Plans||UTMA/UGMA||Life Insurance|
|Control of money||Yes||No||Yes|
|Tax benefits on gains||Yes||Yes||Yes|
|Flexibility on beneficiary||Yes||No||Yes|
|Flexibility on uses||No||Yes||Yes|
|Tax benefits if used on retirement||No||No||Yes|
A competent college planning advisor should be sought out when structuring your financial situation to achieve the greatest benefits possible for college funding. The greatest benefits would include the highest possible funding from sources other than your own pocket and secondary with the lowest possible taxes.