How to save for your child’s college education isn’t as straightforward a choice as would appear. In this blog, we’re going to discuss the decision factors you should consider regarding UTMA vs. 529 accounts if you are considering converting.
Before we get started, you may want to check out other New Jersey finance blogs we’ve written:
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And now onto the blog!
There are critical differences on the FAFSA
There are some pretty important distinctions between 529 and UTMA assets from a financial aid perspective. UTMA/UGMA assets are categorized as an asset of the child whereas 529 assets are considered assets of the parent. For FAFSA purposes, 20% of the child’s assets are assumed to be used for college expenses compared to only 5.64% of the parent’s assets.
It may be better to have the assets classified as being with the parent rather than the child, as reducing the child’s assets on the FAFSA form, the form you use to apply for financial aid from most universities, would deem the child more worthy of financial aid.
If you decide it’s worth it to make the shift and convert your UTMA account into a 529 plan, here is how you would go about it.
Converting from UTMA to 529 plan
Here are the steps you would take if you wanted to convert an account from an UTMA to a 529 plan.
Step 1 – UTMA distribution
The first step is to enact a full liquidation of your UTMA account. When doing so, it’s useful to remember the kiddie tax rules apply to any dividends, interest, or capital gains realized. This is because the UTMA assets are considered to be the child’s assets. This can get a little complicated, so please consult with your CPA or tax advisor if you require clarity on how this may work in your specific situation. Our words are never to be regarded as advice specific to any one individual.
Step 2 – Open and fund 529 account
When you open the 529 account, don’t forget about contribution limits and the annual gift tax exclusion. A couple of key things to remember:
- Contribution limits vary state to state, but are generally high.
- You can contribute more than the annual gift tax exclusion, but your lifetime exemption amount for estate tax purposes will be reduced. Again, consult with your CPA for specifics that apply to your situation.
It’s useful to keep in mind that you are not required to use your own state’s 529 plan when you convert from a UTMA to a 529 account. Also consider that while there is no tax deduction at the Federal level, some states offer tax deductions. When picking a plan, consider the potential state tax benefits, which are usually subject to limitations based upon income, as well as the investment options available.
Step 3 – Invest the 529
After the 529 is funded, you would go through the process of evaluating your risk tolerance and selecting appropriate investment holdings. If you need help with this, consult with a financial advisor.
One more thing!
You may recall that if there are 529 accounts owned by a grandparent, they are not counted as an asset of the child or the parent on the FAFSA.
There have been some very favorable FAFSA changes recently. Distributions from a grandparent owned 529 are no longer counted as income of the child – this differs from how it has been in the past. This makes it easier for grandparents to help their grandchildren save for college using 529 plans. These changes apply only to FAFSA and not to the CSS Profile, which is required for some colleges and universities.
Confused about UTMA vs. 529?
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Kantrowitz, Mark. (2023, August 4th). Saving for College. Should You Convert an UGMA or UTMA to a 529 plan or not? https://www.savingforcollege.com/article/should-you-convert-an-ugma-or-utma-to-a-529-plan-or-not
Flynn, Katheryn. (2024, January 3rd). Saving for College. What to Know About 529 Accounts Owned by Grandparents & the New FAFSA. https://www.savingforcollege.com/article/new-fafsa-removes-roadblocks-for-grandparent-529-plans
IRS. Topic No. 553, Tax on a Child’s Investment and Other Unearned Income (Kiddie Tax). https://www.irs.gov/taxtopics/tc553