31 Dec I saved $200k for college. How will it be taxed?
Q. My grandson recently celebrated his 17th birthday. When he was born, I opened an UTMA account for him with a $3,000 deposit. I am the custodian. Each subsequent birthday, I deposited an additional $1,000 and invested it, and it now has more than $200,000. If he starts college in September 2022 and if tuition and room and board total about $70,000 per year, I would like to draw that amount out of his UTMA account and send it to the college. When I liquidate the stocks in the account, how will it be taxed?
A. This is a wonderful gift you’ve created for your grandson.
We have some tax thoughts for you, but you also need to consider financial aid.
Unlike 529 accounts which are tax-free if used for qualified educational expenses, UTMA accounts, short for Uniform Transfer to Minor Act accounts, are taxable accounts even if used for college expenses, said Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette.
The account is considered to be an asset of your grandson even though you are the custodian, and that’s important for financial aid and taxes.
When you liquidate securities in the UTMA to pay for college, the capital gains will be taxable for federal income tax purposes, Maye said.
There is a wrinkle here with the so-called kiddie tax.
“The tax rate can either be the compressed trust and estate tax rate or potentially be taxed at the parents’ tax rates if the parents qualify and they elect to include the capital gains on their personal tax return,” Maye said.
For more information see IRS Tax Topic 553: “Tax on a Child’s Investment and Other Unearned Income (Kiddie Tax).”
“From a financial aid planning perspective, 529 accounts often make more sense as they are counted as a parental asset if owned by the parent rather than as a student asset,” Maye said.
Maye said the distinction is important because parental assets are counted at a far lower rate for financial aid purposes. For parent assets, 5.64% is considered available to pay college bills versus student assets, which are counted in the 20% to 25% range.
Non-parental 529s are not counted as an asset at all, but rather as student income once withdrawals are used to pay for qualified educational expenses, he said.
“As a result, it can make sense to use the non-parental 529 assets later on so as to not impact financial aid,” he said.
He recommends you consult with a qualified tax professional to determine the exact tax implications and you should speak to the child’s parents to assess potential financial aid impact.
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This story was originally published Dec. 31, 2020.
NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.