UTMA Means Taxes

Sam asks why Dave recommends the ESA and the 529. Are they like an UTMA? Dave explains the differences.

QUESTION: Sam in Chicago asks why Dave recommends the ESA and the 529. Are they like an UTMA? Dave explains the differences.

ANSWER: The UTMA is taxable. The ESA and the 529 are like a Roth IRA. They grow completely tax-free.

To give you some numbers to think about, if you were to save $2,000 a year in an ESA from newborn to 18, that’d be $36,000 you’ve put in. If that’s in a good growth stock mutual fund and it averages 12%, you’re going to have about $126,000 in that account when the kid turns 18. You put $36,000 in, and $126,000 is there. That means you have a $90,000 gain. If that’s in an UTMA, not 100% but a lot of that will have been taxed along the way and won’t be there. If it’s in an ESA, it’s 100% tax-free.

If you put the money into an UTMA instead of an ESA, it will probably cost you $30,000 in that particular scenario I laid out. It depends on how much you’re putting in, how old the kid is, and what the rate of return is, but the scenario I just laid out—you’d have $90,000 there that would be taxable. You’d at least pay $30,000 in taxes on that.

If the returns aren’t great on your daughter’s account, then you have a bad 529. That’s what scares me about those. Sometimes you get with those where they don’t have good mutual fund options in them that have good long-term rates of return. What I would tell you to do is to go to daveramsey.com and click on ELP (Endorsed Local Provider)—that’s the person I endorse locally in your area—and they have the heart of a teacher, so you sit down with them. They’re going to show you and teach you and walk you through the process. Then you’ll make your decision based on that. Then you can roll that 529 to another 529—a better one that’s going to give you better rates of return. If you can pick good mutual funds in there, that’s what you’re looking for.