UGMA's, Coverdell's and Roth's Oh My - by Peter Geckeler
UGMA/UTMA stands for: “Uniform Gifts to Minors Act or Uniform Transfers to Minors Act.” These accounts are owned by a minor who does not have access to the funds until he or she reaches age of majority (age 18 for an UGMA and 21+ for an UTMA). After reaching age of majority, the money can be used for any purpose. These accounts aren't specifically for college, so the beneficiary can use the money for anything once he or she reaches adulthood. The unique aspect of this account is that you do not receive any state or federal tax breaks on the earnings in these accounts. However, earnings will be taxed at the child's rate instead of the parent's rate, which makes these accounts popular savings vehicle for education costs. These accounts also allow for high contribution levels, where an individual can put up to $14,000 a year ($28,000 for married couples) without triggering gift tax rules.
A Coverdell Education Savings Account works very much like a 529 plan, offering tax-free investment growth and tax-free withdrawals when the funds are spent on qualified education expenses. However, the Coverdell account actually allows you to pay educational expenses from the time a child is in kindergarten through college or graduate school. Another benefit is that families can open both a 529 and a Coverdell for the same child. The downside of these accounts is that the Coverdell ESAs have a much lower contribution limit per child when compared to the aforementioned options – only allowing you to contribute $2,000 per year for each child.
Most individuals consider Roth IRAs to be a wise method to save for retirement – which is true – but the account can also be utilized to cover higher education expenses. Contributions into a Roth IRA are not tax deductible, however the contribution amount can grow-tax deferred in the account. In most circumstances, if an individual takes money out of their Roth IRA they are subject to a 10% penalty. Withdrawals from Roth IRAs are actually exempt from withdrawal penalties if the funds are used specifically for qualified educational expenses (tuition, fees, books and room and board). Roth IRAs also enjoy a unique tax treatment, where withdrawals are treated as a "return of contribution" first and as earnings second. This means that a parent can take money out of their Roth IRA - up to what they have contributed into the Roth - in order to cover qualified higher education expenses and not have to pay any tax on the money taken out.
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