Why The 529 College Plan And UTMA Is Horrible For Your Kid And What You Should Do Instead

Why The 529 College Plan And UTMA Is Horrible For Your Kid And What You Should Do Instead

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Before we begin, none of this is meant to constitute any legal financial advice.

I am not a financial advisor.

You should do your own research and consult an actual financial advisor.

“Any financial moves I should do for my kid?”

My friends are having their first kid, a baby boy, during covid-19 quarantine in New York.

They asked me what they if I had any opinions on financial stuff they should do for their kid.

My original piece of financial advice: UTMA account in Vanguard

You’ll eventually hear about why this isn’t a good idea later.

My original piece of advice for them was to open up an UTMA account for their kid the moment they get their kid’s social security number.

What’s an UTMA?

And why would you consider UTMA?

An UTMA stands for “Uniform Transfers to Minors Act.”

To paraphrase Investopedia’s definition, it’s basically an investment account you open up with your child’s social security number and put money into it to invest in stocks, bonds, mutual funds, on the child’s behalf until they come of age (usually 18 years old).

The money completely belongs to your kid and when they turn 18, they can do whatever they want with it.

Seems like the chances of them blowing that money at such a young age is high.

Why would you even consider an UTMA?

Well, any interest or dividends you generate up to $1000 a year is untaxed in their UTMA account.

To give you an example of how much money you’d need to have in their UTMA Vanguard S&P500 index mutual fund so they would be getting $1000 a year in dividends.

Vanguard’s S&P500 index mutual fund usually has a dividend of about 2% paid quarterly.

After some arithmetic, you found out that you need about $50,000 in Vanguard’s UTMA S&P500 index mutual fund to reach that $1000/year in dividends threshold.

investment to get to $1000 in annual dividends for 529 college plan article

You’ll reach that $50,000 in their UTMA real quick and we’ll get to why in a bit.

But the reason why you shouldn’t worry about that threshold is any interest earned after that $1000 is taxed at the kid’s income tax level.

Assuming your kid isn’t making millions of dollars at a young age, it should be negligible tax on the income after that, because what you’re really going to be caring about is the growth on the principle of your money anyways in their UTMA.

The Math of UTMA and how much money your kid could have by the time he’s 18

The premise is simple, every week for the next 18 years, put $100 into the kid’s UTMA vanguard account.

That’s about $400 a month.

With the power of compound interest, assuming a conservative 6% growth annually, he’ll could potentially have $150,000 in his UTMA by the time he’s 18.

compound interest rate calculator picture from 529 college plan article

You put in $100 a week, or $400 a month, and at the end of 18 years, you will have contributed $86,400 but it’s grown to over $150,000.

But let’s be honest, two decades from now, college will probably cost over $100,000 a year and the amount of money you’re putting away will not be enough to cover your kid’s college costs outright.

Which is why every year, you should increase the amount of weekly money you’re putting away toward your kid’s college.

Again we’re going to dive into why UTMA might not be the best idea.

If the parents increase the weekly contribution by $10 each year, the kid could have even more money in his UTMA by the time he enters college.

Like $100/week first year.

$110/week second year.

$120/week third year.

And on and on it goes up till he’s 18 years old.

This could potentially mean over $200,000-300,000 in the kid’s UTMA account by the time he’s 18.

Again, I’m only assuming a conservative 6% growth per year.

Plus, if you can increase each year’s contribution instead of a $10 increase, that would mean more money for his college.

The Downside of UTMA

The kid would have full access to it once he’s 18 years old.

It would be his money completely to use as he sees fit.

It would not be your money and you have no right and no say in how they get to spend it.

They could literally spend it all partying in Ibiza and blow it all on drugs, alcohol, and travel.

Moving on to the 529 college plan.

529 college plan: also horrible idea, here’s why

There are TWO general premises of the 529 college plan.

  1. it’s tax deductible.
  2. the parent maintains control over it even after their kid is 18 years old

Tax deductible? What does that mean?

In layman’s terms, it means that the money you put into the plan can be deducted from your income, so on paper it would look like you’re making less money, and therefore get taxed less/pay less in income taxes.

The 529 college plan can only be used for qualified college expenses.

For example, tuition, books, etc.

But if your kid ends up getting a full ride, all expenses paid scholarship to his college, then you have all this money stuck in a 529 college plan.

I’ve seen some parents reason it to themselves with the excuse “well yeah but what if he decides to go to grad school? I can use it to pay for his grad school. After all, grad school costs a lot of money.”

Again, false.

It depends on the major.

A PhD in a STEM science usually pays a stipend anywhere from $25,000-35,000 a year.

And that was back around 2013 when I was a premed biophysics major looking into PhD programs.

So if your kid ends up in a STEM PhD program, you STILL have all that money in his 529 college plan going to waste, untouched.

Pulling it out will incur tax penalties.

I think the one aspect of the 529 college plan that I’ve noticed some parents liking is that THEY get to control it and not their kid.

Okay, you probably have serious control issues and don’t trust your kid, after all, getting $200,000 in your UTMA when you turn 18 is a huge sum of money to come into (for most kids).

So you want to control how they spend it (i.e., not blow it all on drugs, alcohol, and parties) by opening up a 529 college plan so you can control the withdrawal to make sure it is ONLY going toward education related expenses, etc.

Luckily growing up Buddhist has taught me to relinquish control, because at the end of day, we learn that we don’t have control over anything.

And that is the ultimate way to get control, by giving it away.

But this isn’t a philosophical and spiritual deep dive.


Which brings us to to the ultimate point: just put your kid’s college money into your own investment accounts for 18 years from the moment he’s born to when he goes to college.

The ultimate way: invest in your own accounts for 18 years

This way, if your kid turns out to be a pothead druggy who stays home and plays video games all day, doesn’t want to work to earn a living, has no drive or work ethic to better himself, and is going to live in your basement till he’s 30 (or 40), you don’t have to feel bad that all those hundreds of thousands of dollars are in HIS UTMA or locked away in HIS 529 college plan.

Yes I think we all think “not my kid. My kid is going to be the best kid in the world.”

And okay there’s always that off chance that he’ll be great.

There’s also the off chance he’ll end up being an emotional and financial drain on you for the rest of his life.

Might as well not give him the opportunity nor access to the hundreds of thousands of dollars in his UTMA account that became his money after your hard work of 18 years of investing.

After all, you don’t want to see your almost two decades of hard work be blown on drugs and alcohol as he parties his life away in Ibiza right?

Because that would be totally irresponsible of him to do with your hard earned work and money (note this is a biased opinion based on morals and filial piety and duties and responsibilities of the child to their parents).

But hey, it can happen.

Might as well make your own investment accounts with the same weekly investments.

That way, if he ends up getting a full ride to both undergrad college and grad school, you can now live off the dividends and strive toward FIRE for yourself because your kid is taken cared of.

YES if you save for your kid’s college in your own investment accounts your tax bracket will most likely be higher and you’ll pay higher income taxes on those dividends, etc.

But I think the freedom you have to do with that money as you see fit outweighs the UTMA and the 529 college plan.

And if your kid does get college and grad school full ride, you can now get that beach vacation home you’ve always wanted in Jupiter Island, Florida.

And that, ladies and gentlemen, is why you want to invest in your own accounts while saving up for your kid’s college and NOT in an UTMA or 529 college plan.

Thank you,

Jack The Dreamer

P.S. The money by itself WILL NOT grow if you do decide to put it in an UTMA, 529 college plan, or your personal account.

The money NEEDS to be invested in stocks, bonds, mutual funds because they generally grow faster than the meager savings interest rates of your local bank.

Luckily both Vanguard’s UTMA and 529 college plans allow you select which mutual funds you want to put into the account.

They do the same with your personal account as well.

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Jack The Dreamer

I'm a dreamer. But you know what? All the best people are. And if you're one too, join the revolution! My blog is about being financially independent and working towards that goal each and every single day so that we can all start living the life we've always dreamed of! Jack the Dreamer, over and out!

This Post Has 5 Comments

  1. retirebyforty

    We have about $70,000 in our son’s 529 account. I don’t see what’s the big issue. If our son doesn’t need it, we can change the beneficiary to our niece, nephew, or grand kids someday. Money for education is a good thing. It can be a family scholarship fund if there is any left.

    1. Jack The Dreamer

      Hey RB40! Thanks for commenting! Hmm that’s cool, though I feel like locking the money away in a tax vehicle that’s meant for one singular purpose doesn’t allow the freedom to fully use it. Yes I suppose one could withdraw money out anyways in case of emergencies and deal with the tax penalties, etc.

      But what if all 3 generations of offspring either get full rides, scholarships, or all just decide that they don’t want to go to college?

  2. RV-on-FIRE.com

    We only have one kid so we opted to save in a Roth IRA instead of a 529 in case he decided college wasn’t for him. We didn’t like being tied into the rules of the 529 plan.

    1. Jack The Dreamer

      Right?! I feel like a 529 plan is soooo limiting. But doesn’t a Roth IRA cap annual contributions?

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