Wednesday, June 16, 2010

I want to transfer my UGMA/UTMA into a 529, but I'm worried about losing money, what should I do? 529 College Savings Answers

When our readers and users of send us questions, we'll post the answers here to help anyone searching for information on the best ways to save for someone's college education.

I'm considering a transfer of assets from my child's UGMA/UTMA into a 529, but I'm worried about making the change in a down market, what should I do?

If there is any good news about down markets, the opportunity to transfer assets from an UGMA/UTMA to an UGMA/UTMA-529 could be the silver lining. Transfer requires liquidation and reinvestment of assets. This creates a taxable event. The reason many people hesitate to make this transfer is the reality of paying capital gains tax at the time of the transfer. The benefit of transferring the assets in a down market may be realization of a loss in value rather than a capital gain, depending on the amount originally invested. In actuality, then, a down market could be the perfect time to make such a conversion. Understanding your basis (the amount of dollars actually invested) and whether you would realize a gain or loss is a good question for your tax professional.

There are great reasons to make the conversion from an UGMA/UTMA to an UGMA/UTMA-529. For one thing, instead of paying taxes on the investment, the account becomes tax-benefitted. The IRS also treats these accounts differently. The 529 is a parental asset while the UGMA/UTMA is an irrevocable gift and therefore an asset of the beneficiary. Although this asset must be reported on the FAFSA for the 2009-10 school year, only 5.6% of the 529 value is expected to be used annually for college versus 20% in an UGMA/UTMA account. Thus, your financial “need” increases and your savings will stretch through more years of school.

There is a big “BUT” about making such a transfer: If you are transferring the assets with the idea that the liberal rules of a 529 plan will override the stricter rules of the UGMA/UTMA, think again. While not every state’s 529 plan requires scrupulous reporting of the beneficiary, the obligation to reserve the funds for the original beneficiary remains. The beneficiary is still supposed to obtain control of the funds at age 18 or 21 depending on the state under which your gift was originally structured. In other words, you can rewrap your gift in a different package, but it is still an irrevocable gift.

Share your thoughts: Do you use a 529 or a trust to save for college? What's working better for your family?

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