Useful jargon: UGMA or UTMA in a 529



Dear Joe, Can you convert UGMA or UTMA accounts to a 529 plan? When I opened these college savings tools, 529 was not an option. -- Justin


Dear Justin,
The custodian of UGMA or UTMA funds may invest those funds with a 529 plan. I prefer the label "transfer" over "conversion" to describe the movement of assets out of a taxable UGMA or UTMA investment account and into a 529 plan. The transferred funds still belong to the minor child and you, as custodian, remain subject to the Uniform Gifts to Minors Act, UGMA, or Uniform Transfers to Minors Act, or UTMA.

You will be responsible for making certain that any withdrawals from the "custodial" 529 account are used for the benefit of the minor child. You cannot change beneficiaries on the account, and you must turn over control to the beneficiary at the age established under state law, generally 18 or 21. The enrollment forms for most 529 plans will inquire whether contributions are coming from existing UGMA or UTMA accounts. If you answer "yes," special restrictions may be placed on the account by the plan administrator to protect the interests of the minor.

Transfer boosts federal student aid
Transferring UGMA or UTMA funds into a 529 plan will increase your child's eligibility for federal student aid. Most student-owned investments, including UGMA or UTMA assets, must be reported on the federal aid application, the FAFSA, and are factored into the expected family contribution at the high rate of 35 percent (dropping to 20 percent with the 2007-08 school year). But under recent changes to the financial aid laws, student-owned 529 accounts are not reportable at all and have no impact on your child's eligibility for federal aid.

Parentally owned assets, including parent-owned 529 accounts, are counted for financial aid purposes on a sliding scale that tops out at 5.64 percent. You might wonder if it makes sense for parents to put their own money into student-owned or custodial 529 accounts. I generally recommend against it, for two reasons.

First, you would be giving up your ownership rights in the 529 plan. Forsaking those rights in an effort to reduce your expected family contribution by a small amount (5.64 percent of account value, at most) may lead to bigger problems down the road if your child decides the 529 funds are better spent on things other than a college degree.

Second, some members of Congress apparently feel the treatment of student-owned 529 accounts under the new law created an unintended loophole, and they want to fix it. We may see yet another amendment that assigns a 5.64 percent rate to student-owned 529 accounts, which would make it no better than a parent-owned 529 account, although it would still offer an advantage over other student-owned investments.

Change to 'kiddie tax' hurts
Since a 529 plan can only accept cash, the transfer of existing UGMA or UTMA investments into a 529 plan requires that those investments first be liquidated. The sale may trigger capital gains, so I suggest you plan carefully. Unfortunately, this year's change to the "kiddie tax," which increased the age limit from 14 to 18, means that many families face a much bigger tax bill when liquidating UGMA or UTMA investments. However, it might not be a good idea to wait until your child is 18 before selling those investments. Not only will you be carrying too much market risk in your college savings portfolio, but the reporting of gains just before or during the college years can substantially reduce your child's financial aid eligibility.

If you had known that Congress was going to increase the kiddie tax emancipation age to 18, you probably would not have placed substantial amounts of money into UGMA and UTMA accounts in the first place. Parents of younger children should keep this in mind when deciding how best to save for college. It's why I now refer to UGMA and UTMA as the newest four-letter words.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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