The Uniform Transfer to Minors Act (UTMA) Account and a Section 529 college savings account are two popular vehicles for transferring and gifting assets to minors. Each account has its own rules, as well as its own advantages and disadvantages. In this article, we will review the main characteristics of each type of account and explore when it may make sense to convert the UTMA account to a Custodial 529 Account.

What is an UTMA Account?

The Uniform Transfer to Minors Act (UTMA) is an account established under state law to hold property that is legally owned by a minor. A custodian is appointed to manage the account until the minor owner reaches the age that they are no longer considered a minor under the UTMA law in their state. At that point, the custodian is no longer involved, and the account automatically becomes fully available to the former minor owner. The funds in the UTMA can be used for anything if it is for the benefit of the minor. Contributions to the UTMA are irrevocable and the minor beneficiary cannot be changed.

One of the main benefits of the UTMA account is that certain income generated in the account can be tax-free; however, there is a limit to the amount of investment income that has this preferential treatment. Beyond that limit ($2,200 for the 2019 tax year) the “Kiddie Tax” comes into play with generally higher tax rates. In other words, there is a relatively small window each year for tax-free investment income.

Section 529 College Savings Accounts

A Section 529 college savings account is also an account with an appointed custodian managing the account for the benefit of a named beneficiary, usually a child. Growth within the account can be tax-free if used for certain qualified educational expenses. For more information on the types of expenses that qualify for tax-free distributions, read our post that covers 529 plans for K-12 and college expenses.

A typical 529 account always remains in control of the custodian, and the beneficiary can be changed to certain other family members. Investment options in 529 accounts are more limited than UTMA accounts.

Careful consideration should be given when deciding whether either or both types of accounts would fit each family’s unique circumstances.

Converting an UTMA Account to a Custodial 529 Account

For those who decide to open an UTMA account, or already have one, there is the option to convert the UTMA to a Custodial 529. In this context, a “Custodial” 529 means that the beneficiary cannot be changed. Since the funds in the UTMA account are owned by the minor, a conversion to the Custodial 529 allows the minor to maintain their ownership.

One reason that makes this option appealing is that an UTMA and a Custodial 529 are treated differently on the Free Application for Federal Student Aid (FAFSA) and can provide for a higher amount of need-based financial aid. While the UTMA account would be reported as an asset of the student, a Custodial 529 would be considered an asset of the parent until the minor reaches the relevant age (for example, age 21 for Pennsylvania residents).

Another case for converting would be the tax-free growth of the assets once they are in the Custodial 529. This may make sense if the UTMA account has grown to a point that the Kiddie Tax is inevitable or difficult to avoid.

The potential benefits must be weighed against the downsides of converting an UTMA account, such as the restricted use of the funds for educational expenses and potential taxes due on the sale of the UTMA holdings. However, for certain situations this could be a valuable option. Working with a qualified financial planner can help those families make the choice that is best for them.

UTMA vs. 529 College Savings Accounts: Which is Best for Your Family? appeared on http://rodgers-associates.com/blog/