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Shifting UGMA money to a 529: the pros and cons
Amy Buttell is a freelance writer based in Pennsylvania
For many years, Uniform Gift to Minors Act accounts, or UGMAs, were by far the best way to transfer assets to your children to finance their college education. But as 529 plans have gained traction, it may make more sense to transfer funds in a UGMA account to a 529 plan, according to Joe Hurley, founder of Savingforcollege.com, a website focusing on 529 plans and other college savings vehicles.
Before you decide to transfer your child or grandchild's UGMA funds to a 529 plan, you should consider the pros and cons. While 529 college savings plans offer a number of advantages over UGMAs, the decision isn't a slam-dunk. UGMAs are tax-advantaged, custodial accounts that parents and grandparents can set up for the benefit of a minor child.
One benefit UGMAs offer over 529 plans is flexibility, says Joe Spada, a Certified Financial Planner with Summit Financial Resources in Parsippany, N.J.
"With an UGMA account, you can invest the money however you want. So, if you want to trade into different stocks and bonds or pick your own mutual funds, you can do that," he says. "Also, you can spend UGMA funds on anything for the benefit of the child, not just on college-related expenses like with a 529 plans."
However, UGMAs are taxed in certain situations, says Hurley. They also revert to the control of the child when that child reaches the legal age of majority in his or her state of residence.
Funds in UGMAs may be subject to the "kiddie tax," which is a tax your child may have to pay on investment income at your tax rate. Under the kiddie tax, children between the ages of 14 and 24 who are in school full-time must pay taxes at their parents' higher tax rate rather than the child's lower rate on unearned income of more than $1,900, Hurley says. But 529 plans are not subject to the kiddie tax.
Also, UGMAs are less favorable from the financial-aid perspective because colleges count them as an asset of the child rather than the parents. Because colleges assess student's income at a higher percentage than a parent's when doling out aid, more of that money must be spent on the current year's tuition than with a 529 college savings plan, Hurley adds.
If you do decide to transfer your UGMA to a 529 plan, follow these three steps:
- Select a 529 plan. Before you transfer the money, you have to pick a 529 plan and make a decision about how the funds in the 529 will be invested, because you cannot transfer your investments from a UGMA to a 529 plan, says Spada. It makes sense to double-check with the particular 529 plan to make sure that it will set up a 529 plan with UGMA funds, but usually that's not a problem, he adds. On the downside, selling your UGMA investments before setting up a 529 may trigger the "kiddie tax" if you have taxable capital gains from the investments held in the UGMA account, Hurley says.
- Fill out the 529 plan paperwork. Whether you already have a 529 plan or are opening a new plan with the UGMA money, you need to fill out forms with your 529 plan to transfer the funds. Specify that those funds are coming from a UGMA account, says Marina Goodman, a Certified Financial Planner at Brinton Eaton, a wealth management firm in Madison, N.J.
- Transfer the funds. Once you fill out the paperwork with the 529 plan, the plan custodian will contact the UGMA custodian to directly transfer the money from the UGMA to the 529 plan. The UGMA custodian will sell any mutual funds, stocks, bonds or other securities before making the transfer since you can only transfer cash, says Spada.
Once the money is transferred and your 529 college savings plan is up and running, you may be able to take a state tax deduction for your contribution if your state allows such deductions or credits, says Hurley. Also, because the 529 plan funds were transferred from an UGMA account that was set up to benefit a specific child, you can't transfer those funds to another child like you could with a regular 529 plan, Spada says.
However, you do retain many of the other advantages of a 529 plan, Goodman says. Any money you take out of the 529 plan for qualified college expenses will be tax free. The money in the account is under the control of the 529 plan's account custodian until the child reaches the age of majority, and then it is under the control of the child, says Hurley. However, if the child removes the funds for a non-qualified expense, the IRS will assess a 10 percent penalty and taxes may be due.
Posted June 18, 2010