K.B. of Lake Success, NY writes:

I have an UGMA account for my child, who will be entering high school this fall. Should I also have a 529 account? Which is better? Can I rollover the UGMA into a 529 Plan?

The College Whisperer responds:

The old "UGMA versus 529" debate.

Not much of a debate, really, when one looks at the benefits of a 529 account juxtaposed against the drawbacks of an UGMA or UTMA account.

UGMA (Uniform Gift to Minors Act; UTMA -- Uniform Trust -- in some states) is an irrevocable gift to a child which can be used for the child's benefit (other than for parental obligations) until he or she reaches legal age (18 or 21, depending on the state), and then becomes the sole property of the child/now legal adult.

Then, the question may become, "College, or that Audi convertible?"

Back in the days before 529 Plans, the savings vehicle touted by financial advisers, short of E-Bonds and Cloverdale accounts, was the UGMA/UTMA account. These were literally out-and-out transfers of assets to the child, which could be tapped by the parents for Junior's benefit (need not be college, or even education). At legal age, the assets belonged to Junior, to do with as he pleased.

Benefit of UGMA/UTMA? Primarily, a presumed tax savings, as the accounts (or a portion thereof) are taxed at the child's rate, typically lower than that of the parents.

Drawbacks? Almost too many to mention.

UGMA/UTMA accounts are taxed. Transactions (i.e., the sale of assets) are subject to tax. Gains are subject to tax. Rollovers into other accounts, including 529 Plans, are taxed.

The assets are owned by the child. Good luck using that money for college if your now "of age" son has other plans for it.

As the assets of an UGMA/UTMA are owned by the child -- and this is a big disadvantage -- colleges consider the assets as those of the child in determining financial aid awards.

With the advent of the 529 Plan -- SEE New York's version at nysaves.org -- UGMA/UTMA's generally fell into disfavor among the savvy parent or grandparent saving for college.

Why? Well, consider the following.

Money contributed to a 529 Plan (which can only be used for expenses related to higher education, both undergraduate and graduate) may provide a hefty tax deduction. [In New York, a married couple filing jointly may deduct up to $10,000 in annual contributions from their NYS income taxes. Not too shabby!]

Money invested, which is owned by the parent (or grandparent/guardian), grows tax-free, and may be withdrawn (again, only for college-related expenses), tax-free, for the benefit of the child (who is the beneficiary, not the owner).

Assets of a 529 Plan are NOT considered the assets of the child, and are NOT included in the FAFSA test for determining EFC -- Expected Family Contribution. In other words, unlike UGMA/UTMA assets, the 529 Plan will not have any impact on a college's financial aid award. And since Junior is the Plan's beneficiary, and not its owner, no chance he'll use the dough you've stashed away for a summer share on the Jersey Shore rather than for room and board at State U.

Should Junior decide not to go to college, not to worry. 529 Plans permit owners to change beneficiaries, without penalty, or, if necessary, to withdraw funds outright, albeit with penalty, including a 10% federal penalty, in addition to tax consequences.

Taking the leap of faith that the kids will go to college, the 529 Plan is the best bet for saving and growing money for college, while UGMA/UTMA should be relegated to the likes of saving for a down payment on Junior's first house.

Can you rollover your UGMA/UTMA into a 529? The short answer is yes, with the proviso that UGMA/UTMA assets must be liquidated to do so, triggering a taxable event. [There are also contribution limits established by the 529 Plans, so be aware.]

For more on the benefits of a 529 Plan, check out savingforcollege.com and www.sec.gov/investor/pubs/intro529.htm.

Be sure to consult with your financial adviser before investing, and with your college planning counselor before setting out on that long road to college.

The views and opinions expressed in this blog are solely those of The College Whisperer.
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