What is the best way to save for a child or grandchild? Many people think the most important issue is saving income taxes. Saving the money in a Uniform Gifts to Minors Act account (UGTMA) provides some tax benefits although savings are limited because of the kiddie tax. However, investment options are nearly unlimited in an UGTMA account. Putting the money into a 529 College Savings Plan has better income tax benefits but the money has to be used for higher education expenses to get the tax benefits. Investment options are usually limited in a 529 Plan.
I think the bigger consideration is control. Money put into a UGTMA account is a completed gift. In most states the money belongs to the child at age 21. Until age 21 the account is controlled by the custodian. Think back to your own financial decisions at age 21. Is this the best time to turn over control to a young person? Even if the child has been responsible with financial decisions, the significant other (boyfriend or girlfriend) can influence financial decisions that would be contrary to the way you intended your gift be used.
The 529 plan offers a few more control options. The account never has to be turned over to the child and in fact can be redirected to a different person altogether. You could even assign it back to yourself and use the money for your own higher education so the withdrawals would be tax free. Withdrawals become an issue when you want to use the money for something other than higher education expenses. Should the child not need the money for education expenses or you would rather they have it to make a down payment on a house, penalties and taxes apply.
Saving money for your children and/or grandchildren is a good idea, but it doesn’t have to be done in a separate account to save taxes. Consider the cost of losing control and compare it to the tax savings before you decide.