UTMA and UGMA Custodial Account Conversions - Moving to a 529 Plan

Should You Do UGMA or UTMA Custodial Account Conversion?

529 Investment Application
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UGMA and UTMA custodial accounts reigned supreme over the college savings market until the creation of Section 529 accounts in 1996. Since that time, more and more investors have chosen Section 529 plans for their combination of tax benefits and parental control over the assets. With that in mind, it’s no surprise that many parents and grandparents who had previously utilized UGMA and UTMA custodial accounts are feeling a little bit cheated.

Hence, one of the major questions asked by parents who have assets invested in an UTMA or UGMA custodial accounts, is whether or not they are permitted to convert their account to a Section 529 plan. Thankfully the answer is “Yes.” However, an UTMA-529 or UGMA-529 conversion does come with some hypothetical catches.

Control of the Assets

Most notably, an UTMA or UGMA-529 custodial account conversion does not technically allow a parent to avoid giving the assets to their child when they reach age 18 or 21 (depending on the state). I say technically, because only some Section 529 plan sponsors require special handling and labeling of a UGMA or UTMA-529 conversion. In these instances, the specific account is labeled as a “Custodial Section 529 account” and the plan sponsor will turn the assets over to the minor when they reach adulthood, just as if it was a classic custodial account.

There are some plans sponsors however, that do not require this special account treatment even though the legal obligation remains for the parent or grandparent.

Additionally, it is completely up to the parent to be honest as to the source of the money when they fill out the Section 529 new account form. However, lying about the source of the money is not advisable, since it is both illegal and allows your child to sue you for mismanagement of their money.

Beneficiary Changes

You are not supposed to use a UTMA or UGMA-529 custodial account conversion to change the beneficiaries of a custodial account.

In essence, that would equate to giving your child’s money to someone else. Again, some plan sponsors do not require you to disclose this fact on the front end, and all plans that do take you at your word as to the source of the funds. If you make a UGMA or UTMA-529 conversion and report it honestly, most plans will not allow a change of beneficiary until the current child becomes the outright owner. At that point, the grown child is permitted to change the beneficiary from themselves to someone else.

Tax Consequences of an UTMA or UGMA-529 Custodial Account Conversion

Unlike IRA’s that penalize you if you withdraw your money and invest it in a non-IRA account, an UGMA or UTMA-529 conversion has no such penalty. However, your investments may be subject to capital gains tax if they have a previously unrealized gain. This may be offset though, by the benefit of having all future growth on the money be sheltered under the new Section 529 plan.

Effect of Financial Aid From an UTMA or UGMA-529 Custodial Account Conversion

A UGMA or UTMA-529 conversion is generally considered a smart move when it comes to qualifying for financial aid. This is because the assets of a custodial account are counted as the child’s assets, whereas the assets in a converted 529 account are counted as the parent’s if the student is still a dependent.

This means that by converting a UGMA or UTMA account to a Section 529 account, only 5.64% of the assets are expected to be used annually, as opposed to 20% prior to the conversion.

For more details on making a UGMA or UTMA-529 custodial account conversion, considering calling your state’s Section 529 plan sponsor or talking to your investment and tax advisors.