Withdrawal Rules for Different Types of College Saving Accounts

Here Are the Rules for UTMA, UGMA, Section 529, and Coverdell ESAs

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During a financial crisis, families are forced to consider using the funds they've set aside for college savings accounts to help make ends meet. But can you withdraw money from a custodial account? Unfortunately, not always—at least not without a significant penalty.

When families start saving, they may be uncertain of how much money will be available to their family through federal financial aid—or they may want to prevent their child from taking on unmanageable federal student loans in the future—and thus they contribute aggressively. But when their budgets are stretched thin, they may be left without a choice but to take money out of the college fund.

Before college savings are needed for a child, and before a family's budget is in jeopardy, students and parents should consider the different rules and tax implications for various college funds, and decide which is best for their long-term financial outlook. Plans like UTMA and UGMA Custodial Accounts, Section 529 Plan Accounts, or Coverdell Education Savings Accounts are all unique, and financially flexible in their own ways.

UGMA and UTMA Rules for Withdrawal

UGMA and UTMA Custodial Accounts allow adults to make financial gifts to a beneficiary while naming someone else (including themselves) as the custodian of the account. The crucial word for these accounts is “gift.” The money in these accounts, once given, is the legal property of the beneficiary. The custodian’s job is to keep the fund safe and invest it wisely so that the beneficiary (a minor) will be able to use it for their education at a later date.

UGMA and UTMA accounts are often used to pay for college, but can also be used for any expense the minor incurs—anything from basic costs of living to leisure activities like team sports. The custodian must be able to prove that the minor directly benefits from the use of the money.

There are no IRS penalties on taking money out of a UGMA or UTMA account. Profits made on the liquidation of investments in a child’s UGMA or UTMA account are generally reported on the child’s tax return, but some or all might be included on the parent’s tax return, at the parent’s tax rate, depending on how the family files its federal taxes.

Section 529 Plan Withdrawal Rules

In 2019, there was an estimated 14 million Section 529 savings plans with total assets since 2009 reaching $352.4 billion.

Section 529 plans were designed to allow parents to retain more control than the UGMA and UTMA accounts. Someone who has contributed to a Section 529 plan can access the money at any time, for any reason. The contributor does not have to worry about explaining it to anyone, and the expense does not have to be for the benefit of the child.

The caution here is that money that is withdrawn from a Section 529 plan that is not used for higher education expenses will be subject to at least a 10% penalty, as well as all applicable income taxes for the account's profits. Any underlying investments may also charge an additional fee.

Coverdell Education Savings Account (ESA) Withdrawal Rules

The non-educational withdrawal rules on a Coverdell ESA fall somewhere between the Section 529 Plan rules and the UGMA/UTMA rules. The money invested is considered a gift to the beneficiary, but it can be rolled over to another beneficiary if the first doesn’t have qualifying education expenses by age 30.

Better yet, a beneficiary or custodian is not bound to using this account for exclusively higher education. While it can’t be used it for food or clothing, as a UGMA or UTMA account can be, it can be used for educational costs that occur before college. These costs can include K-12 private school tuition, tutoring, books, school uniforms, and technology, such as a personal computer or laptop.

If the money is used for qualified educational expenses, the money can be withdrawn completely tax-free. If it is not used for qualified education purposes (such as during a family emergency or economic crisis) the portion of the distribution that represents a gain is taxed to the beneficiary as income, and is also subjected to an additional 10% penalty.

Frequently Asked Questions (FAQs)

How do you transfer a UTMA account to a child?

While they technically own the funds, children cannot take control of custodial accounts. They must wait until they reach adulthood (usually age 18, but it's determined by state law). Once a child reaches that age, the UTMA is terminated, and the funds are either withdrawn or transferred to another account.

What are the income limits for Section 529 plans?

There aren't income limits for contributing to Section 529 plans. Anyone can create or contribute to a Section 529 plan, regardless of their annual income level.

Who owns the funds inside a Coverdell education savings account?

The designated beneficiary owns the funds in a Coverdell account, but it isn't outright ownership. The funds must be used for qualified education expenses, and the ownership of unused funds can be transferred to another beneficiary.

Article Sources

  1. U.S. Social Security Administration. "SI DEN01120.205 Uniform Gift to Minors Act."

  2. Fidelity Investments. "Must-Know Facts About UGMA/UTMA Accounts."

  3. The Vanguard Group. "Vanguard UGMA/UTMA Account."

  4. Walsh & Associates. "Withdrawal Rules for 3 Popular College Saving Accounts."

  5. Internal Revenue Service. "Topic No. 553 Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)."

  6. College Savings Plan Network. "529 Savings Plans: 2019 Mid-Year Data," Page 1.

  7. Fidelity Investments. "What Is a 529 Plan?"

  8. U.S. Securities and Exchange Commission. "Investor Bulletin: An Introduction to 529 Plans."

  9. Internal Revenue Service. "Coverdell Education Savings Accounts Can Make Education Costs Less Taxing," Page 1.

  10. Internal Revenue Service. "Publication 970 (2019) Tax Benefits for Education," Pages 46-47.

  11. Internal Revenue Service. "Publication 970 (2019) Tax Benefits for Education," Pages 52-54.