Q. In 2002, I started putting money into 529 plan. However, the monies came from a Uniform Transfers to Minors (UTMA) account. What tax ramifications are there?
A. The short answer is: it depends.
We realize you may have already taken action, but here’s what you need to know.
While it is true that 529 plans offer a number of advantages over UTMA and UGMA (Uniform Gifts to Minors Accounts) accounts, there’s lots to consider.
UTMAs are tax-advantaged, custodial accounts that parents and grandparents can set up for the benefit of a minor child, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.
However, one of the problems is that the UTMA reverts to the control of the child when that child reaches the legal age of majority in his or her state of residence, he said
Additionally, UTMAs are less favorable when calculating financial aid.
This is because the UTMA account is counted as an asset of the child’s on the FAFSA application, but assets in a 529 account are counted as belonging to the parents if the student is still a dependent, he said.
“For example, with a 529 plan only 5.64 percent of the assets are expected to be used annually by the parents towards tuition, as opposed to a full 20 percent being used by the student from his UTMA,” DeFelice said.
While assets in a 529 plan are not subject to any tax on the growth as long as they are used to pay for qualified higher education costs, UTMAs may be subject to the “kiddie tax.”
“Under the new 2018 kiddie tax rules, children between the ages of 14 and 24 who are in school full-time must pay taxes at their parents’ higher tax rates,” he said..
Now to the UTMA-to-529 plan conversion.
DeFelice said it has no tax penalty per se.
“However, the underlying investments in your account may be subject to capital gains tax if they have a previously unrealized gain,” he said.
He said for the UTMA account, interest and short-term capital gains are taxed as ordinary income, while long-term capital gains and qualified dividends are taxed at capital gains rates – most likely 15 or 20 percent depending on your income.
So this has to be weighed against the benefit of sheltering all future growth on the money in a 529 Plan.
Additionally, DeFelice said, when 529 plan funds originate from a UTMA account, you lose the ability as the parent to change beneficiaries on the new 529 plan because that would equate to giving your child’s money to someone else, he said.
“If you make a UTMA-to-529 conversion and report it honestly, most plans will not allow a change of beneficiary until the current listed beneficiary becomes the outright owner at age of majority – usually 18,” he said. “At that point, the grown child is permitted to change the beneficiary from themselves to someone else if he or she so desires.”
Before making any decision on an UTMA-to-529 account conversion, it is a good idea to call your 529 plan sponsor and consult with your investment and tax advisors.
Email your questions to moc.p1548027288leHye1548027288noMJN1548027288@ksA1548027288.