COMPARISON OF SECTION 529 PLANS TO UNIFORM

TRANSFERS TO MINORS ACT ACCOUNTS

    Traditionally many families saved for their children’s higher education by establishing and funding a custodial account for each minor child under their state’s Uniform Transfers to Minors Act or "UTMA" (formerly called Uniform Gifts to Minors Act or "UGMA").

    From an estate planning perspective, the downside of a parent establishing an UTMA account and naming himself or herself as custodian is that, while the transfer is a completed gift for federal gift tax purposes, the custodial property will be includible in the parent’s gross estate if death occurs while the account is still in effect. Moreover, the child is entitled to receive all the property remaining in the account when he or she attains majority.

    Current income tax law creates a disadvantage for using UTMA accounts by requiring that all unearned income of a child under age 14 in excess of a certain amount be taxed at the rate of the child's parents. Since the earnings in the UTMA account by definition are taxable, this tax burden will likely erode the amount available to spend on education.

    From a financial aid viewpoint, the UTMA account assets are considered the child’s, so that 35% of the assets are deemed available for college expenses, thus reducing the chances of the student qualifying for financial aid.

TRANSFERRING AN EXISTING UTMA OR UGMA ACCOUNT INTO A 529 PLAN

    Many but not all Section 529 Plans accept funds being transferred from an existing UTMA or UGMA account. However, because these assets are owned by the minor, subject only to the custodian’s control before the child reaches majority, the assets cannot be treated as regular funds contributed to the Section 529 Plan account by a contributor where the account owner would retain the right to change the beneficiary and recover the account balance at any time.

    As a result, most states permitting transfers from UTMA or UGMA accounts segregate them into separate sub-accounts governed by special rules that are consistent with the child’s irrevocable ownership. For example, the contributor/custodian  is prohibited from making any beneficiary changes to that account, and the minor will become the owner of that sub-account when the custodianship terminates.

    If the primary reason the parents want to make the change is to delay the child’s control of the funds beyond the age of majority as defined in the applicable state statute, a Section 529 Plan will not be effective for this purpose. However, the transfer of UTMA or UGMA funds into a Section 529 Plan account will provide the family with the income tax exemptions and investment benefits achievable with 529 plans.

    One potential hurdle for such a transfer is the requirement that a Section 529 Plan can only accept cash. Thus, capital gains tax may have to be incurred by the child as a condition for being able to access the Section 529 Plan.

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