As parents or future parents, a frequent question we encounter is: "What vehicle should I use to save for my child’s education?" Two popular—or often considered—choices are 529 college savings plans and UTMA (Uniform Transfers to Minors Act) custodial accounts. Each option comes with its own benefits, drawbacks, and trade-offs. Often, a strategic combination of the two can provide flexibility, tax efficiency, and more options.

In my opinion, you should never leave your children's money just sitting in the bank. We teach our kids about the rule of 72, which states that by dividing your rate of return into 72, you can determine how long it will take to double your money. For instance, a 10% return will double your money every 7.2 years (10/72 = 7.2). However, your local bank typically offers around 1% interest on savings. There's a bank in my hometown that entices kids with gimmicks: open an account, deposit money, and spin a wheel for a small prize, while they lend out your child's $10,000 savings at 6%, earning $600 a year and paying you very little. This arrangement benefits the bank. If the money will remain untouched for 10, 15, or even 20 years, it's probably better to invest it. Options like the UTMA or the 529 can provide this opportunity.

What if my child receives a birthday check from grandma? That's wonderful—you don't need a bank to cash your child's check. You can easily deposit that check into their 529 or UTMA account. Your child shouldn't visit a bank to conduct transactions until you're teaching them how to effectively manage a checking account. Avoid the misconception that a 2-year-old needs a savings account.

It's important to understand that a 529 or UTMA can also be held in a savings account. Simply opening these accounts doesn't mean the funds are automatically invested. You need to actively invest the money once it's in these accounts. Therefore, we suggest consulting a Financial Advisor who can offer personalized advice suited to your specific circumstances.

Below is a comparison and a framework I often use (with caveats) in working with families.

What is a 529 plan? What is a UTMA?

529 Plan (Qualified Tuition Programs)

• A 529 plan is a tax-preferred savings vehicle created under Section 529 of the Internal Revenue Code.

• Contributions are made with after-tax dollars (i.e. no federal deduction, though many states offer state tax deductions or credits). You can use this tool from Scholars Edge 529 to see if your state has a tax benefit.

• The key benefit: tax-deferred growth, and tax-free withdrawals when used for qualified education expenses (tuition, fees, books, supplies, and in many cases room & board).

• If you withdraw funds for non-qualified purposes, earnings are subject to income tax plus typically a 10% penalty.

• For financial aid purposes, because the 529 is usually owned by a parent, it is considered a parental asset, and its impact on aid eligibility is relatively modest (roughly 5.64% of the value is assessed in many FAFSA formulas).

• 529 plans often have aggregate contribution limits (which in many states are well above $300,000) and may allow contributions from multiple family members, subject to gift tax rules.

  
  

UTMA (Custodial) Accounts

• A UTMA account (Uniform Transfers to Minors Act) is a custodial account in which an adult (the custodian) holds assets for a minor. Once the child reaches the age of majority (depending on state law), the assets become fully theirs.

• There is no restriction on how the money is used. Essentially, any expense that “benefits the child” is allowed (not just education).

• The assets and their growth are taxed annually under special rules. The first $1,350 is tax exempt (no taxes), and the next $1,350 is taxed at the child's tax rate, which is 10%. Gains after that are taxed at the parents' tax rate.

• Because the account is in the name of the child, for FAFSA financial aid calculations, it is considered a student asset, which hurts aid eligibility more (roughly 20–25% of the account’s value may count).

• There are no contribution limits specific to UTMA (though gifts above the federal gift-tax annual exclusion may trigger reporting).

  
  

Why you can’t “double-dip” with education tax credits + 529 on the same tuition dollars

One critical nuance many families overlook: you cannot claim the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC) on tuition dollars that are paid using 529 plan distributions. In other words, the same dollar of tuition can’t get a 529 tax benefit and be used to generate a tax credit.

AOTC and LLC income limits

• For the American Opportunity Tax Credit: The full credit phases out for taxpayers with Modified Adjusted Gross Income (MAGI) between $80,000 and $90,000 (single filers) and $160,000 to $180,000 (married filing jointly). Above those thresholds, you lose eligibility.

• The Lifetime Learning Credit has the same phase-out ranges ($80,000 to $90,000 for single, $160,000 to $180,000 for married).

• If your income is above those top ends, you cannot claim the credit at all.

• Because of this limitation, in higher-income families, funding entirely via 529 may make sense. But in “middle” income or borderline cases, you might want to preserve flexibility so you can use the tax credits.

  
  

As a practical example, if you pay a child’s tuition of $8,000 in a given year:

• If you pay it via a 529 withdrawal, that $8,000 is “used up” in the sense that it cannot also be used to claim an education tax credit.

• If instead you pay out-of-pocket (or from a taxable account) the first $4,000 and claim the AOTC on that, and perhaps use 529 withdrawals or other sources for the remainder, you may get more total tax benefit—especially if your income keeps you within the credit phase-out range. The AOTC and LLC are pretty powerful tax credits. The AOTC, for example, is a maximum of a $2,500 annual credit (per eligible student) for the first $4,000 of qualified expenses, and even 40% of the credit is refundable (meaning if you have no tax liability, the IRS pays you). Because credit works for the first $4,000 of qualified educational expenses, perhaps a $4,000 payment from your UTMA (which wouldn't only cost you $1,500 after your tax credits) and the balance from your 529 would optimize your situation.

  
  

Thus, blindly “filling up” a 529 account and using it for all of college costs might leave money on the table if you are in a position to benefit from AOTC or LLC.

My Guiding Strategy: Use UTMA early, then shift to 529

In working with many families, I often recommend a hybrid, staged approach, though always with the caveat: each family’s situation (income, estate plan, risk tolerance, anticipated college cost, state tax environment) can change the calculus.

Here’s a sketch of the approach I often favor:

1. Begin with UTMA (custodial) funding for the early years, targeting a specific threshold (e.g., $10,000–$20,000).

   • In those early years, the growth in a UTMA (assuming good investment returns) is often small relative to the child’s tax brackets and possibly below the kiddie tax thresholds. For example, a 10% return on a $5,000 account balance is $500. This is under the $1,350 that is tax-free; therefore, you would get the same benefit you get in a 529 plan (tax-free growth), but you wouldn't be limited to using the funds for educational purposes.

   • You retain full flexibility: the money in UTMA isn’t forced to be used for education. If the child doesn’t go to college, or if circumstances change, you can repurpose it for a home down payment, business startup, or other purposes.

   • You preserve the ability to use the education tax credits (AOTC or LLC) on tuition dollars because you haven’t locked all funds into a 529 yet.

     
     

2. Once the UTMA reaches the threshold (say $10k–$20k), begin shifting new savings toward a 529, gradually increasing the proportion allocated to the 529 over time.

   • The reason: the compounding and tax-free benefits of the 529 become more powerful as the balance grows.

     
     

3. If desired, convert or “roll” portions of the UTMA into a 529 (if allowed by your state) in years when the tax impact is minimal and before the FAFSA/aid calculation year.

   • But beware: converting/cashing out UTMA for 529 contributions triggers capital gains and unearned income in that year, which may push some income into the kiddie tax or higher brackets.

   • It may be smart to spread the realization of gains from the UTMA over several years, to avoid “bunching” too much income in one year.

     
     

Why this blend works: you get some flexibility and tax credit optionality early, and then lean into the tax-advantaged compounding of the 529 later. It’s a balance.

Illustrative savings goal: $166/month from birth

To show how meaningful this strategy can be, consider this hypothetical:

• Suppose you commit $166/month starting at your child’s birth for 18 years.

• If the portfolio earns 10% annually, the future value is roughly $98,900

• At 8% return, it would grow to about $79,600

• At 6% return, it would hit around $64,800

  
  

These are strong sums—especially given the many options available to your child (college, trade school, first home, etc.).

If you began with a UTMA cushion of, say, up to $10–$20k, the portion still invested in the 529 would benefit from decades of compounding at tax-free growth.

Key Trade-Offs & Risks to Watch

• Kiddie tax & unearned income: If unearned income in a UTMA is larger than the $2,700 ($1,350 at 0% and $1,350 at 10%), it may be taxed at the parent’s marginal rate under the kiddie tax rules.

• Financial aid impact: UTMA assets are more heavily penalized in FAFSA calculations (student asset) than 529s (parental asset). That can significantly reduce need-based aid.

• Conversion tax liability: If you convert from a UTMA to a 529, any capital gains must be realized and reported, which can trigger higher tax costs if done poorly.

• State tax differences: Some states provide deductions or credits for contributions to in-state 529 plans—benefits UTMA doesn’t enjoy.

• Changing plans: If your child decides not to attend college, 529 funds not used for education could face penalties and taxes (unless you roll to another beneficiary or use under certain permitted options). There is also now a provision that allows you to move 529 plans to a child's Roth IRA after the funds have been in the 529 plan for 15 years.

• Income limitations on tax credits: If your family income is high (above the phase-out thresholds), the benefit of preserving options for credits may be minimal, and an all-529 strategy may be more attractive.

  
  

Putting it all together: What to consider when designing your plan

When crafting a savings strategy for education, here are key questions to ask:

1. What is your current and projected income? If your income is likely above or close to the AOTC/LLC phase-out, you may not get much benefit from preserving credit eligibility.

2. How much flexibility do you want? Do you want to ensure the funds are used for education, or do you want the option to repurpose them? If you value using them for purposes other than education, you would lean more towards the UTMA.

3. What is your risk tolerance and investment preference? The more years remain and the more willing you are to invest the account into stocks, the more the 529’s tax-free growth becomes compelling.

4. How will this interact with your larger financial plan? College funding is one goal among many (retirement, estate planning, liquidity, etc.). You don’t want to over-prioritize a college account at the expense of other goals.

5. What is your state’s 529 tax incentive? If your state offers a deduction or credit for 529 contributions, that tilts the balance more in favor of 529.

6. When to convert UTMA to 529, if ever? Plan ahead for capital gains, timing around FAFSA, etc.

   
   

In many cases, a hybrid “UTMA-first, then shift to 529” strategy gives you a “best of both worlds” pathway—especially for families in the middle-income range who are trying to maximize tax credits and maintain flexibility.