In the past, many people opened custodial accounts in their child’s name under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA). To keep it simple, we will refer to both types of custodial accounts as UTMA. UTMAs provide a place for relatives and others to make gift contributions of as much as $14,000 (2013 amount) a year. Plus, the first $1,000 of investment income is tax-free for children under age 19 with another $1,000 taxed at the child’s rate. Any income above $1,900 is taxed at the parents’ rate. Once the child reaches 19 years of age (24 if the child is a full-time student), all income is taxed at the child’s rate. For many parents, the purpose of these accounts was to shift income to their child who was in a lower tax bracket and to save for the child’s college education.
Many parents are now asking the question, “Can I transfer the balance of my child’s UTMA or UGMA to a 529 Plan?” 529 Plans may appear more attractive than UTMAs since the earnings are tax-free provided the funds are used to pay for your child’s college education. But can you make the switch? You can, but there are some restrictions. First, you must be the custodian of the UTMA. You need to make sure the 529 Plan you are considering accepts contributions from UTMAs. You can sell the holdings of the UTMA and invest in the 529 Plan. However, you lose one of the great features of a 529 Plan—the ability to change the beneficiary of the 529 account. Funds of UTMAs belong to the child, and they continue to belong to the child in the 529 Plan. If your child decides not to go to college, he will have to pay a 10% penalty plus income taxes once the 529 account is distributed.
Beware of cashing out the UTMA and opening a 529 account in your name (the parent’s). This could lead to some serious legal problems since your child (not you) owns the UTMA.
Depending on the age of your child, it may make more sense to continue the UTMA than to sell the holdings and pay income tax on capital gains. Speak with your financial adviser or accountant to determine if you should switch to a 529 Plan or contribute to one going forward. If you would like any further information regarding this issue as well as any other tax related issue, please contact Henssler Financial at 770-429-9166 or experts@henssler.com
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
