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Education Savings Options – Part 2: Coverdell ESA, UTMA/UGMA, Taxable Brokerage Account, & Roth IRA

Tyler Weerden

Coverdell Education Savings Account (ESA)

An ESA is a tax-advantaged savings account strictly for education purposes. Contributions can only be made for a beneficiary under age 18, or if they have special needs. After-tax cash contributions grow tax-deferred and withdrawals are tax-free if used for eligible education expenses. There is no tax deduction for an ESA contribution. Just like a 529, if you use the money for non-education expenses, you’ll pay ordinary income tax on the earnings and a could pay a 10% penalty.

 

The annual contribution is limited to $2,000 per child each year, even if they have multiple ESAs. Regardless of the number of donors, all of you can only contribute a combined $2,000 per beneficiary. Similar to IRAs and HSAs, the ESA contribution can be made by the tax filing deadline, meaning you could make a 2024 contribution up until April 15, 2025. There are income limits for ESA contributions. For single filers, the phase-out starts once your Modified Adjusted Gross Income (MAGI) reaches $95,000. Once you surpass $110,000, you’re ineligible to contribute any amount. For Married Filing Joint (MFJ), the contribution phase-out begins at $190,000 and no contributions are allowed after surpassing $220,000.

 

ESA funds must be fully distributed from the account by the time the beneficiary has turned 30 or has died, unless they’re over age 30 and have special needs. If the funds are distributed from the account due to the beneficiary dying or turning 30, the earnings portion still counts as taxable income. Contributions are not taxed when distributed since they were made with post-tax dollars. The funds can remain in the account if the beneficiary of the deceased ESA owner is a qualifying family member.

 

Before the Tax Cuts & Jobs Act of 2017, ESAs were popular due to their ability to be used for elementary and secondary school expenses. Qualified elementary and secondary education expenses include: tuition, fees, text books, tutoring, special needs equipment, uniforms, transportation, and room & board (at least half-time enrollment required for room & board). Now that 529s can also be used for K-12 tuition payments, ESAs are slightly less attractive due to the income restrictions and contribution limits. Unlike 529s, ESAs are not capped at $10,000 for elementary or secondary schools (public, private, and/or religious).

 

Similar to 529s, you can change the beneficiary of an ESA to a family member of the original beneficiary as long as the new beneficiary is under age 30 or special needs. Like a 529, ESAs can be rolled over into another family member’s ESA once every 12-months following the 60-day rollover rule. The sweeping IRS definition of family member that we saw with 529s is the same family member list for ESAs.

 

For needs-based financial aid purposes, ESAs are considered “parental assets” and therefore will be valued at 5.64%, as opposed to the 20% for UTMA/UGMA custodial accounts. This means your Expected Family Contribution / Student Aid Index (SAI) could be affected by an ESA. Like with 529s, some private institutions will not disregard ESA assets and/or income from a grandparent or non-relative held ESA, which could negatively affect financial aid.

 

Uniform Gift to Minors Act (UGMA) /Uniform Transfer to Minors Act (UTMA)

UTMA/UGMA custodial accounts aren’t just for education. Donors can place assets (money, securities, property) in these accounts for a beneficiary under the age of 18. There are no income restrictions to make a contribution and no maximum contribution amount. Contributing over $19K each year will reduce the lifetime estate/gift tax exemption and require filing IRS Form 709. $19,000 is the annual gift exclusion in 2025.

 

There is no up-front tax deduction, no tax deferral, and no tax break upon withdrawal, regardless of what the funds are used for. You’ll pay tax on the interest, dividends, and capital gains each year. In 2025, for children under 18, or dependent full-time students ages 19-23, the first $1,350 of unearned income is tax-free. The next $1,350 is taxed at the child’s rate. Assuming the beneficiary has minimal to no income, this means the first $2,700 of investment gains could be tax-free in 2025. Anything over $2,700 is taxed at the parent’s tax rate. The “Kiddie Tax” is used to prevent parents from placing assets in their children’s accounts to avoid taxes.

 

Two warnings regarding UGMA/UTMA custodial accounts.

 

(1) When the minor reaches the “age of majority” (18-25 depending on the state), they own that account and have complete control. If they want to buy a boat with the funds, they can.

 

(2) For student aid, custodial accounts are categorized as student assets, meaning 20% (FAFSA) / 25% (CSS Profile) of the account value could be applied to reduce student aid. Moreover, up to 50% of the income generated from the account could be taken into consideration as student income.

 

Each custodial account can only have one beneficiary that cannot be changed. Assets placed into the UTMA/UGMA are irrevocable gifts which cannot be withdrawn. If the minor dies, the assets go to their estate. Custodians have a fiduciary duty to make decisions that are in the best interest of the minor. The custodian (as long as they’re not the donor) can also reimburse themselves for “reasonable expenses” associated with managing the account. Funds may be withdrawn prior to the age of majority, but only for expenses directly related to the child’s benefit. These expenses cannot be for basic life support needs like food, shelter, or clothing.

 

Every state allows for the opening of an UGMA and/or UTMA account. UGMAs were created first and can hold traditional assets like cash, stocks, bonds, and mutual funds. UTMAs are a newer form of custodial account and have been adopted by every state. South Carolina became the last state to adopt UTMAs in 2022. UTMAs can still hold traditional assets but can also hold things like partnership interest, royalties, patents, fine art, and tangible property like real estate.


Taxable Brokerage Account

Too many restrictions? Qualifications? Income Limits? Complicated taxes? I get it. If you don’t want to do any of the options previously discussed, consider a plain vanilla taxable brokerage account in your name. There are no education funding police (other than your in-laws). You can start investing money in a taxable brokerage account titled in your name, instead of your child’s name. This is the Swiss Army Knife of accounts.

 

There are no income limits, no requirement to have earned income, no contribution maximums, no rules saying that you have to use it for education, you can tax-loss or tax-gain harvest annually, there’s a step-up in basis for heirs, you can gift shares and possibly eliminate tax for you and the receiver, and you have unlimited investment options. If you’re worried about an 18-year-old’s maturity level, this investment account fits the bill. This account won’t automatically transfer to your child when they reach the “age of majority” since you’re the account owner.

 

Note: You will have to pay tax each year on the interest, dividends, and profit/capital gains, but don’t let this stop you. You can invest tax-efficiently to minimize annual taxes. When you sell assets held longer than a year, you’ll get to pay more favorable long-term capital gains tax (0%, 15%, or 20%). This is more preferable than paying the ordinary income tax rate you pay on your W2 income (10%, 12%, 22%, 24%, 32%, 35%, or 37%).

 

Another added benefit to this account is that the assets will count as “parental assets”, meaning only 5.64% will be counted for FAFSA, versus 20% if held in a custodial UTMA/UGMA account.

 

Roth IRA

It pains me to even mention this as an option.

 

In 99.99% of scenarios, I think this a terrible idea that you should not consider. Your Roth IRA is for your future financial freedom. You need let that tax-free money continue to compound. Don’t forget, you can never go back and re-contribute money taken out.

 

Roth IRA contributions can be taken out tax and penalty free at any time, any age, for any reason. This ability to access contributions is not unique to education expenses.

 

What comes into play with education expenses specifically, is the ability to access earnings before age 59 ½ without paying a 10% early-withdrawal penalty.

 

If you do decide to use your Roth IRA for qualified education expenses, and you’re under age 59 ½, you’ll pay ordinary income tax on the earnings but will be exempt from the 10% early-withdrawal penalty. The education expense allowance can be used for you, your spouse, kids, or grandkids. Expenses can include tuition, fees, books, supplies, required equipment, and room & board (room & board requires at least half-time enrollment). The institution must also be approved, which basically means any college, university, or vocational school eligible to receive Title IV federal student aid.

 

A Warning for Student Aid.

While retirement accounts (401(k), 457(b), 403(b), TSP, IRAs) aren’t considered assets when determining student aid eligibility, the distributions are considered income and could affect future financial aid. This includes tax-free return of contributions from a Roth IRA.

 

To read Education Savings Part 1 – 529 Plans, click here.

 

For more detailed information, refer to IRS Publication 970, Tax Benefits for Education.

 

About the Author

Tyler Weerden, CFE is a financial planner and the owner of Layered Financial, a Registered Investment Advisory firm. In addition to being a financial planner, Tyler is a full-time federal agent with 15 years of law enforcement experience on the local, state, and federal level. He has served in both domestic and overseas Foreign Service assignments. Tyler has experience with local, state, and federal pension systems, 457(b) Deferred Compensation, the federal Thrift Savings Plan (TSP), Individual Retirement Arrangements (IRAs), Health Savings Accounts (HSAs), and invests in rental real estate. He holds a Bachelor of Science degree, a Master of Science degree, passed the Series 65 exam, and is a Certified Fraud Examiner (CFE).

 

Disclaimer

Layered Financial is a Registered Investment Adviser registered in the Commonwealth of Virginia and State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Nothing in this article should be seen as a recommendation or advertisement. Layered Financial and its Investment Advisor Representatives have no third-party affiliations and do not receive any commissions, fees, direct compensation, indirect compensation, or any benefit from any outside individuals or companies. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments, types of investments, products, or companies are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment, solicit the business, or use that product. The author of this publication may hold positions in investments or types of investments mentioned in articles. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances. 

 

© 2025 Tyler Weerden. All rights reserved. This article may not be reproduced without express written consent from Tyler Weerden.

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