What Is an UTMA/UGMA 529 Plan?
An UTMA/UGMA 529 plan is a custodial 529 college savings plan account funded with money from an existing Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) account. It differs from a traditional 529 plan in several important respects.
- You can move money from an existing UTMA or UGMA account into a 529 college savings plan.
- The major advantage is that you may be eligible for more financial aid.
- The major disadvantage is that you’ll lose the ability to use the money for purposes other than education.
Understanding UTMA/UGMA 529 Plans
Before the introduction of state-run 529 college savings plans, many parents invested for their children’s education and other major financial goals through UTMA or UGMA custodial accounts. The two types of accounts are very similar, although an UTMA can hold a wider range of investments, including real estate and fine art.
When states began rolling out 529 college savings plans in the 1980s and ’90s, UGMA and UTMA accounts lost much of their appeal for college savers. The new 529 plans offered a number of tax advantages that UGMAs and UTMAs did not, including state tax breaks for contributions in many states and no federal taxes on earnings or withdrawals as long as the money in the plan was used for qualified educational expenses. UGMAs and UTMAs still exist, but people who use them today are likely to have goals other than paying for college in mind.
For families with college-bound children and money in an existing UGMA or UTMA, it’s possible to move that money into an UTMA/UGMA 529 custodial account. But is it a good idea?
Pros and Cons of UTMA/UGMA 529 Plans
If you’re considering switching from an UTMA or UGMA to one of these special 529 plan accounts, here are some of the pros and cons to consider.
You could get a break on financial aid.
You retain control over what the money is used for.
You lose flexibility in what you can use the money for.
You have to liquidate the account, which will result in a tax bill.
Pro: You Could Get a Break on Financial Aid
In typical financial-aid formulas, money that’s held in a child’s name, as with an UTMA or UGMA, is more likely to reduce your aid eligibility than money held in a parent’s name, as is the case for 529 accounts. And even though a custodial 529 technically belongs to the child, it is considered a parental asset for financial aid purposes.
Specifically, when the Free Application for Federal Student Aid (FAFSA) determines your expected family contribution toward college, it counts 20% of the student’s assets but no more than 5.64% of the parents’ assets. So if you expect to be eligible for aid, moving the money into a 529 could be advantageous.
The Expected Family Contribution (EFC) element of the FAFSA application is being replaced with a Student Aid Index (SAI) for applications starting October 2022. The changes are intended to simplify the application process and widen eligibility for student aid.
Con: You’ll Lose Some Flexibility
Money in an UTMA or UGMA can be used for any purpose as long as it is for the benefit of the child whose name is on the account. So if a child needs orthodontia, for example, that money is available.
In a 529 plan, however, money that is not used for qualified educational expenses—which include tuition, room and board, and required fees—incurs taxes and penalties. The SECURE Act, passed in 2019, expanded the law to also allow for tax-free withdrawals of up to $10,000, per lifetime, to repay qualified student loans.
What’s more, unlike the money in a traditional 529 plan, money in an UTMA/UGMA 529 plan can only be used for the qualified educational expenses of that particular child and can’t be transferred to a sibling or other family member.
Pro: You’ll Maintain Some Control
The money in UTMA and UGMA accounts belongs to the child. A parent or other adult serves as custodian and, as mentioned, can use that money for the child’s benefit. However, when the child reaches a certain age, typically between 18 and 25, the money is theirs to do with as they please. That might mean paying for college, making the down payment on a first home, or blowing it all on a trip to Hawaii. It’s entirely the child’s call.
With a 529 plan, on the other hand, the money has to be used for educational expenses. Otherwise, it is subject to both taxes and penalties. In that way, opening an UTMA/UGMA 529 plan provides at least some assurance that the money will be put to a good purpose.
Con: You’ll Face a Tax Bill
To move your money from an UTMA or UGMA into a 529 plan, you’ll have to liquidate those assets. That means your child will incur income taxes on any untaxed appreciation or earnings in the account. If the account was invested in mutual funds, for example, you or your child have probably been paying tax on your account’s dividends and capital-gains distributions every year, so you may not owe all that much. However, if your account was invested in real estate or some other asset that has appreciated but not spun off taxable income every year, you could be in for a substantial bill.
That said, once the money is in the 529 plan, you’ll start to enjoy some tax advantages. Any appreciation or income going forward will not be taxable as long as the money is eventually used for qualified educational expenses. So if you’re thinking of making a switch, doing it sooner rather than later could help you make the most of the tax savings.
The more money that's in a child's UGMA or UTMA account, the more impact it will have on their financial-aid prospects. So if the balance is relatively low, switching to a 529 may not be worth the effort.
The Bottom Line
Moving money from an UTMA or UGMA account into an UGMA/UTMA 529 plan has some advantages, especially when it comes to financial aid. However, it will limit your flexibility in what you can spend the money on, and it may also have some negative tax implications.
Because much of the law regarding UTMAs, UGMAs, and 529 plans is state-specific, it’s a good idea to check with your state, or a knowledgeable financial advisor, regarding whether it allows such transfers and, if so, what its particular rules are.