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Should you open an UGMA/UTMA 529?
What is an UGMA/UTMA 529?
It refers to account in a 529 plan funded with money already owned by your minor child. Because minors generally cannot directly own an investment or bank account, an adult custodian must manage and use the funds for the benefit of the minor child as prescribed under the state's Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). Another name frequently used for a 529 account opened with UGMA/UTMA money is "custodial 529 account."
Nearly all 529 savings plans have special procedures to accommodate UGMA/UTMA 529s. For example, the plan administrator will not permit changes in the beneficiary designation prior to the current beneficiary's 18th or 21st birthday (depending on the state). And when the current beneficiary reaches the age of legal ownership, he or she will have the right to contact the 529 plan administrator and take direct ownership and control of the 529 account.
I'd like to put my son's UTMA money into a 529 plan without telling the plan where the money is coming from. That way my son will still be the beneficiary, but I'll be the owner and can control the account without worrying about what happens when my son turns 18. Is there anything wrong with this approach?
Establishing the 529 account in your own name as owner does not change the custodian's legal obligation under the UTMA to use the funds for the benefit of that particular child. If you were to change the beneficiary and use the 529 money for a different child, or deny your son's right to take direct ownership at the age of 18 (if that is the legal age in your state), you are probably in violation of the UTMA. An attorney can help explain this to you.
If you are worried about your son making poor decisions because of this money, you might better look for ways to "spend down" the account while he is still a minor. If you were to use the UGMA/UTMA account to pay for expenses incurred for his benefit, instead of paying for those expenses yourself, you will have more money to fund a 529 account under your own ownership.
I've heard that UGMA/UTMA 529s have been granted favored status under the financial aid laws? Is this true?
Yes, it is true. Beginning with the 2006-07 school year—but ending with the 2008-09 school year—your child's UGMA/UTMA 529 does not have to be reported on the federal financial aid application (FAFSA). The same exception applies if the UGMA/UTMA has terminated and your child (the student) owns the 529 account directly. But note: this special rule applies only if your child files the FAFSA as your dependent, which is the case for the vast majority of undergraduates.
The treatment of an UGMA/UTMA 529 changes beginning with the 2009-10 school year, but is still beneficial. The account is reportable on the FAFSA, but not as a student asset assessed at the usual 20% student rate. Instead, it is reported as a parental asset at the lower 5.64% maximum parental rate. The fact that an asset owned by one party (in this case the student) is treated as if it is owned by another (the parents) is highly unusual in the financial aid laws.