Did you set up a custodial account to save for college expenses when your child was young? Have you ever wondered if it made sense, or was even possible, to move those assets into 529 plan? Well, it is possible, and it may make sense for you to make the effort, depending on your situation.
First, some background on Section 529 plans and custodial (UGMA/UTMA) accounts.
Section 529 plans, such as the Idaho College SavingsĀ Program (IDeal) are today's preferred education savings vehicle. These plans, which started becoming available in the late 90's, enable parents (and grandparents or other interested parties) to save considerable amounts for their children's higher education expenses, with investments growing tax-deferred until they are distributed tax-free for qualified educational expenditures. They are simple to set up and there are plenty of good (and bad) plans to choose from. To top it off, many states (including Idaho) offer generous state tax incentives to utilize the home state plan.
Prior to the arrival of 529 plans, UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Trust for Minors Act) custodial accounts were the most popular method for tax-favored college savings. These custodial accounts are used to hold and protect assets for a minor until they reach the age of majority. (In Idaho this is age 18 for UGMA accounts and age 21 for UTMA accounts.) When using a custodial account to save for college, the investment earnings within the account are taxed to the minor, not the parent/custodian. In 2009, youth can make up to $1,900 in unearned income (e.g. investment income in their custodial account), paying nothing on the first $950, and only 10% federal income taxes on the next $950. Above $1,900 in unearned income, the investment earnings are taxed at the parents' higher marginal tax rate--the so-called "kiddie tax". (The "kiddie tax" used to only apply kids age 14 and under. In 2006 the age was raised to 18. In 2008 it was broadened further to include students, age 19-23, who earn less than half his or her individual support.)
Although custodial accounts provide potential tax advantages to families saving for college, there are a few key disadvantages.
As you will see in Part 2, transferring a custodial account into 529 plan is a viable strategy to deal with this last issue (the impact on EFC), but is little help in allowing parents to regain control of the funds they placed in custodial accounts.
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