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Should you open an UGMA/UTMA 529?
Okay, let's forget about financial aid for a moment. Is there an income tax savings from moving my child's UGMA/UTMA money into an UGMA/UTMA 529?
There could be substantial tax savings, assuming your child would otherwise be paying income tax on taxable interest, dividends, or capital gains. The 529 account will grow tax-deferred, and come out tax-free to pay for college.
But wait, it's not quite that simple. Your dependent child can report as much as $950 in investment income in 2009 without being subject to federal income tax. If your college savings never threw off more than $950 in annual income, you might be better off keeping the UGMA/UTMA invested in mutual funds and other taxable investments. (A 529 plan has the disadvantage of a small layer of additional fees, as well as the risk of future tax and penalty if the 529 account is used for something other than college.)
You also have to consider the tax consequences of moving the money from the taxable investment into the 529 plan. Triggering any gains this year may cost more in taxes when compared to spreading out the gains over a number of years.
If the existing UGMA/UTMA taxable investments are throwing off more than $950 in annual income, the analysis turns in favor of the 529 option. Although the income between $950 and $1,900 remains taxable at the child's low tax bracket, if it rises above that level it may become taxable at the parents' marginal tax bracket. This rate bump is known as the "Kiddie Tax" and beginning in 2008 it applies to the following three groups of taxpayers: (1) children through the age of 17; (2) 18-year olds who do not earn more than one-half of their own support; and (3) 19- to 23-year-old full-time college students who do not earn more than one-half of their own support.
Because of the control issues, the Kiddie Tax, and the financial-aid consequences, most families looking to invest substantial dollars for college should be looking toward 529 plans and away from UGMA/UTMA accounts.
Joe Hurley is the founder of Savingforcollege.com LLC, and a certified public accountant.
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