Financial Planning Blog

In Part 1, the key disadvantages of an UGMA/UTMA custodial account for college savings were listed. In recent years many people have taken advantage of the capability to transfer custodial assets into Section 529 college savings plans as a way to overcome at least some of these drawbacks.

Transferring a custodial account to a 529 plan

The custodian of an UGMA/UTMA account can move the assets to a 529 plan, but a number of restrictions generally apply. Most 529 plans, including IDeal, require the transferred assets be set up in a separate "custodial Section 529 account", so they cannot be combined with other 529 contributions. The "custodial 529 account" will still be subject to UGMA/UTMA restrictions, most importantly:

• The beneficiary/child will still gain control of the account at age 18.
• The custodian cannot change beneficiaries, unlike a normal 529 account.

For more details on moving assets from an UGMA/UTMA account into IDeal, see pages 12-13 in their disclosure statement.

Although transferring the custodial assets to a 529 plan does not eliminate these account control issues, there are a couple of potential advantages.

• Even though the custodial 529 account becomes the student's asset at 18, for financial aid purposes it will be counted as the parents' asset and assessed at only 5.64% for the EFC. (As explained in this article, this treatment of custodial 529s is new starting in 2009.)
• Depending on your family's situation, moving the money into a 529 account could help the student qualify for more financial aid than if the money is left in the original custodial account. As long as the assets are used for qualified educational expenses, the tax benefits of a 529 plan are superior to those of an UGMA/UTMA custodial account. The amount of the potential tax benefit will depend on investment returns, how long the funds are invested, and the family's tax situation.

A couple of more things to consider before transferring custodial funds into a 529 plan:

• The 529 plan can only be funded with cash. This means that the custodial assets must be liquidated before transferring them into the 529 plan. The tax implications of this liquidation should to be considered before going forward.
• Don't wait too long to do the conversion. You obviously want to have this done prior to completing the FAFSA (Free Application for Federal Student Aid). Also, if the liquidation of the custodial account creates significant realized income, you probably don't want that to show up on the tax return used for the FAFSA.

The concept of starting early to save for college expenses is pretty simple, but following through with the disciplined savings is the real work. If you have planned ahead, diligently saved, and utilized tax favored accounts--great job! Unfortunately, many of you still need to navigate the web of two very complex systems--taxes and student financial aid. Whoever thought saving for college could get so complicated?