“The biggest reason is tax savings.” says John Wiggins of WhatIsA529Plan.com, “All the earnings from investments in a 529-plan account are tax exempt, while only a portion of the earnings in a UGMA or UTMA account are tax exempt.”Both UGMA and UTMA accounts, together generally referred to as UGMA accounts because they’re so similar, pale in comparison to 529-plan accounts, which were created in 1996.
Under one scenario, the 529-plan account would actually be owned by the UGMA or UTMA account. Experts in college saving say the tax advantages associated with 529-plan accounts, and the fact that the stock market has been so weak lately, make such a move doubly attractive.
In a 529-plan account, investments grow tax-free and, under the Tax Relief Act, distributions for educational expenses are taken tax-free as well. Only a portion of the earnings in UGMA and UTMA accounts are tax-free.
When a child is under 14, the first $750 of earnings each year is exempt from federal and state taxes, the second $750 is taxed at the child’s rate, and the rest is taxed at the parent’s rate. If the child is 14 or older, all earnings are taxed at the child’s rate.
Liquidating UGMA and UTMA account assets, however, and then taking the proceeds and putting them into a 529-plan account can bring a host of problems – most of them relating to ownership.
UGMA and UTMA accounts are custodial accounts, the contents of which belong to the child, meaning the assets of the 529-plan account purchased with the proceeds of the liquidated assets of a UGMA or UTMA account would belong to the child.
Normally, the assets of the 529-plan account belong to the parent.
UGMA and UTMA accounts also present a problem with respect to financial aid for college. Most financial-aid formulas impose a penalty for assets owned by the student.
They also pose a problem for parents who just need to get ahold of the money in a UGMA or UTMA account. Because the accounts are irrevocable gifts, the assets in them must be used for the child.
A 529-plan account is not irrevocable, although there is a 10% penalty on earnings for taking the money out before the child reaches a certain age.
Of course, issues of ownership can be sidestepped by just spending down an existing UGMA or UTMA, using the proceeds for the child’s needs and buying a 529-plan account with new dollars independent of the UGMA, says Joseph Hurley, founder of Savingforcollege.com.
Even Mr. Hurley admits that such a solution might not work for a child from a family that just doesn’t have the money to sink into a 529 plan.
Of course, the custodian of a UGMA or UTMA account could just liquidate the account and move the money into a 529-plan account without telling the 529-plan administrator where the money was coming from, suggests one financial adviser.
Here is a side by side comparison of 529 Plans and UGMA/UTMA Accounts:
Whatever decision you make be sure you contact your financial adviser for consul and help with doing this.