You’ve been gifting cash and securities into an UGMA/UTMA account that was established for a child years ago. Should you now convert the account to a 529 plan?
The answer depends on financial, tax and financial aid tradeoffs. Timing also matters.
Financial and Tax Consequences
Here are a few reasons why it might or might not make sense to convert the UGMA or UTMA account.
Minimal Tax Benefit from Conversion
The existing UGMA or UTMA account is probably already very tax-efficient, and the extra tax benefits of a 529 plan may not add up to much.
Under the Kiddie Tax Rules for tax year 2026, the standard deduction shelters the child’s first $1,350 of unearned income completely. Unearned income includes investment income, such as interest, dividends and capital gains. The next $1,350 of unearned income is taxed at the child’s income tax rate (10%). Any unearned income over $2,700 is taxed at the parent’s tax rate.
It takes a rather sizable UGMA or UTMA account to generate that much taxable unearned income each year. Also, consider that the kiddie-tax income threshold adjusts periodically for inflation, so check current-year figures to confirm.
Conversion Triggers a Big Tax Bill
All of the untaxed capital gains in the existing UGMA or UTMA account will be reported as unearned income if converted to a 529 plan. Contributions to a 529 plan must be made in cash, which requires liquidating the UGMA or UTMA account.
The bunching of capital gains in the year of conversion, as opposed to spreading them out over several years, makes kiddie-tax problems much more likely. And if the kiddie tax applies, instead of being taxed at the child’s 10% tax rate, the unearned income is subject to the parents’ much higher income tax rate (likely 22% or 24%).
By not converting, you can carefully manage capital gains in the existing UGMA or UTMA account over several years to minimize or avoid the kiddie tax and take full advantage of the child’s 10% tax bracket.
State Income Tax Benefits
More than two-thirds of the states offer a state income tax deduction or credit on contributions to a 529 plan (though you may have to contribute to your state’s 529). This is a benefit that is available on 529 plans but not UGMA or UTMA accounts. However, you could make new contributions to a 529 plan account instead of the UGMA or UTMA account without doing a conversion.
Higher Expense Ratio
Most 529 plans charge a management fee. Although plans have reduced fees dramatically over the years, they are still an extra cost that may work against the decision to convert.
Better Investments in a 529 Plan
Of course, this analysis assumes that you use the exact same investments in the existing UGMA or UTMA account and in the 529 plan. This rarely turns out to be the case. In fact, the investments offered by a 529 plan may be better quality and/or lower cost than what the UGMA or UTMA account is currently invested in. The 529 plan may also offer a beneficial investment strategy – an age-based investment option – that is difficult to replicate outside of a 529 plan.
Lower Returns as College Approaches
An age-based asset allocation shifts the investment mix to a lower percentage equities as college approaches, bottoming out at 10% to 20% in stocks. Thus, the investment returns may not be much different than in the UGMA or UTMA account a few years before the child enrolls in college.
Financial Aid Impact
Financial-aid eligibility is the wild card that favors moving the UGMA or UTMA account assets into a 529 plan. The financial aid consequences can exceed the tax savings from keeping the money in an UGMA or UTMA account.
Students report UGMA/UTMA assets as student assets on the Free Application for Federal Student Aid (FAFSA). Student assets on the FAFSA add significantly to the Student Aid Index (SAI), which in turn can decrease financial aid eligibility. The SAI is increased by 20% of the value of the student’s assets. But assets in a 529 plan are reported as parent assets on the FAFSA, whether they are owned by the parent or the dependent student. Parent assets are assessed on a bracketed scale that maxes out at 5.64% when determining the SAI. In dollar terms, $10,000 held as a student asset raises the SAI by $2,000, while the same $10,000 held as a parent asset raises it by no more than $564.
The assets reported on the FAFSA are as of the date the student files the FAFSA. So, there is a financial aid advantage to conversion up until the time you submit the FAFSA. (Keep a printout from the UGMA or UTMA account and 529 plan web sites showing the new account balances if the conversion occurs after the most recent statement prior to the FAFSA filing date.)
Just be careful to time the conversion so that the triggering of capital gains does not work against financial aid eligibility. The FAFSA considers income from the prior-prior year, so any income on or after January 1 of the sophomore year in high school is reported as income on the FAFSA. The SAI will increase by as much as half of this income.
Use our Financial Aid Calculator to estimate your financial need based on student and parent income and assets and other criteria.
The Bottom Line
If converting an UGMA or UTMA account into a 529 plan account makes sense in your situation, remember to do so before January 1 of the sophomore year in high school. Otherwise, the capital gains from liquidating the UGMA or UTMA account will significantly reduce the student’s eligibility for need-based financial aid.
It is best to spread out the capital gains over several years prior to this year, to take maximum advantage of the standard deduction under the kiddie tax rules.
Use Saving for College’s UGMA/UTMA 529 Conversion Calculator to evaluate the impact of converting an UGMA or UTMA account into a custodial 529 college savings plan. This easy-to-use tool requires a subscription for access.
[The original version of this article was written by Joe Hurley. It was updated and rewritten by Mark Kantrowitz on July 9, 2020, and has been periodically updated since.]
