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Accounts for Young Grandchildren: 529 or UTMA?
Old 11-26-2020, 10:37 AM   #1
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Accounts for Young Grandchildren: 529 or UTMA?

Recently, we were considering opening 529 educational plans for our two very young grandchildren, and maybe funding them with $3,000 to $4,000 a year. But then I was reading how it might be possible to gift appreciated stock to a minor through an UTMA account and the minor (i.e., the UTMA custodian) would take the basis of the appreciated stock and potentially sell it, up to a limit, with no tax consequences and then reinvest the proceeds. That is, it seems with even the “kiddie tax,” the minor might be able to absorb up to $2,200 a year in capital gains with no tax consequences. Anyone had experience with this before? Is this a good way to gift to minors? One thing we are not worried about is the fact that with the UTMA we maybe give up more control than with the 529.
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Accounts for Young Grandchildren: 529 or UTMA?
Old 11-26-2020, 05:35 PM   #2
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Accounts for Young Grandchildren: 529 or UTMA?

I chose 529 plans for my three grandkids. I get a reduction in state income tax here in Pennsylvania. I can also change the beneficiaries if needed do that if they don’t go to college, I can help another family member’s child. I can pass along ownership of the account to my wife or my sons if needed.

The 529 website for PA has a good estimator of what you need to save for the type of school you want to send them too. I’m shooting for a Penn State main campus or equivalent. It’s eye opening. I started school of the accounts with $20,000 and adding about $3,000/year each. I’m way behind.
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Old 11-26-2020, 05:51 PM   #3
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One thing we found was that it can be worthwhile to shop different state plans. DW found that Iowa invested primarily in Vanguard funds, which suits our style. I see now that they offer a lot of options, not sure that was the case at the beginning. In our case, we get a small state rebate for contributing to a 529, regardless of which one. So shopping was a no-brainer.
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Old 11-26-2020, 05:56 PM   #4
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Originally Posted by OldShooter View Post
One thing we found was that it can be worthwhile to shop different state plans. DW found that Iowa invested primarily in Vanguard funds, which suits our style. I see now that they offer a lot of options, not sure that was the case at the beginning. In our case, we get a small state rebate for contributing to a 529, regardless of which one. So shopping was a no-brainer.


Yes, Pennsylvania and Utah also use Vanguard funds. We have them in an age based aggressive portfolio that moves more to bonds as they age. PA also allows tax deductions regardless of which 529 plan we use.
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Old 11-26-2020, 06:39 PM   #5
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Old 11-26-2020, 08:15 PM   #6
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I went the UTMA route because I had $25K of very much appreciated stock. I could gift the shares to my 6 grandchildren and they would get the full value of the stock.

If I would have used 529, I would have to sell the stock, pay 24% Fed Tax, another 5% state tax, and the gifts would then total $17.7K instead of $25K.

The grandchildren can then slowly diversify and pay 0% Capital Gains tax. They can use the funds for education, weddings or to purchase their first house.

I lost the potential tax deduction, but the year I was gifting, I had a very low effective tax rate (part of the reason I did it then).

For us, it was the better choice.
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Old 11-26-2020, 08:51 PM   #7
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My dad started 529s for my sons.... He seeded them with $10k each. When he passed, I inherited them and we contributed monthly to them.
As mentioned - you can transfer beneficiaries if you need to. Also - 529's belong to the owner (parent or grandparent) not the kid... Which can help with financial aid by FAFSA rules. In fact, if it's owned by grandparents - it doesn't even show on the FAFSA applications. I think (but am not sure) UTMAs are owned by the kid -so they can hurt any financial aid. FAFSA considers assets owned by the kid 100% available to pay for college.
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Old 11-26-2020, 10:14 PM   #8
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Originally Posted by rodi View Post
As mentioned - you can transfer beneficiaries if you need to. Also - 529's belong to the owner (parent or grandparent) not the kid... Which can help with financial aid by FAFSA rules. In fact, if it's owned by grandparents - it doesn't even show on the FAFSA applications. I think (but am not sure) UTMAs are owned by the kid -so they can hurt any financial aid. FAFSA considers assets owned by the kid 100% available to pay for college.
Yes, you can change the beneficiary - generally to a pretty broad variety of relatives (siblings, cousins, parents, etc.).

529 assets are the child's but 529 accounts also have a custodian - usually the parent or grandparent. For FAFSA purposes, 529s with the parent or student as the custodian are treated as parental assets and thus are "FAFSA taxed" at a lower rate than student assets.

While grandparent 529s (or aunt/uncle 529s) are not reported on the FAFSA, any 529 distributions from those accounts I believe are counted as untaxed income to the student in the year of distribution, which is "FAFSA taxed" at 50% for that year (which is two years later nowadays, so a grandparent 529 distribution in 2020 would affect FAFSA aid applied for in October 2021 for the 2022/23 school year.

UTMAs are student assets, and while they are 100% available to pay for college like any student asset, they are only "FAFSA taxed" at a rate of 20%.

Do note that some schools use CSS Profile for their school-granted financial aid. CSS Profile rules are different from FAFSA rules.

...

OP, I'd look at a few factors:

1. Do you want your gifting to be intended for college?
2. Do you think (at least some of) your grandkids will go to college?
3. Are your state tax deductions for 529 contributions valuable to you?

The more you lean towards "Yes" on these three questions, I'd lean towards a 529. The more you lean towards "No" on these three questions, I'd lean towards a UTMA.
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Old 11-27-2020, 08:15 AM   #9
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We did 529's for the 10 grandkids. We are done contributing to six of them (one college graduate, two currently in college, three HS juniors) but are still contributing for the other four.
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Old 11-27-2020, 08:18 AM   #10
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Originally Posted by rodi View Post
My dad started 529s for my sons.... He seeded them with $10k each. When he passed, I inherited them and we contributed monthly to them.
As mentioned - you can transfer beneficiaries if you need to. Also - 529's belong to the owner (parent or grandparent) not the kid... Which can help with financial aid by FAFSA rules. In fact, if it's owned by grandparents - it doesn't even show on the FAFSA applications. I think (but am not sure) UTMAs are owned by the kid -so they can hurt any financial aid. FAFSA considers assets owned by the kid 100% available to pay for college.
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Old 11-27-2020, 09:48 AM   #11
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"One important caveat is the difference in treatment if someone other than the parents or student—such as a grandparent—owns the 529 plan. In that case, while these 529 savings are not reported as a student asset on the Free Application for Federal Student Aid (FAFSA), any distribution from this 529 plan is reported as income to the beneficiary, potentially resulting in a significant reduction in eligibility for need-based aid the following year."



The above is from Fidelity:
https://www.fidelity.com/learning-ce...-savings-plans
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Old 11-27-2020, 09:57 AM   #12
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I went the UTMA route because I had $25K of very much appreciated stock. I could gift the shares to my 6 grandchildren and they would get the full value of the stock.

If I would have used 529, I would have to sell the stock, pay 24% Fed Tax, another 5% state tax, and the gifts would then total $17.7K instead of $25K.

The grandchildren can then slowly diversify and pay 0% Capital Gains tax. They can use the funds for education, weddings or to purchase their first house.

I lost the potential tax deduction, but the year I was gifting, I had a very low effective tax rate (part of the reason I did it then).

For us, it was the better choice.
I appreciate all the responses, but what levindb describes above is why we are considering the UTMA over the 529. Here in California I believe there are no front end tax advantages in usng the 529 (e.g., there is no state tax deduction for contributions to the 529), but of course there is the back end advantage of tax free growth if used for education, which is the ultimate purpose of $$$ gifted to our young grandchildren.

But now I am thinking maybe we can gift our appreciated stock to an UTMA in the names of our grandchildren, and encourage the custodians (i.e., our adult children) to sell it and reinvest it in the 529s they have set up for the grandchildren. That would give tax advantages at both the back and the front end. But would need a financial advisor, I guess, to tell us if this is legit.

Anyways, thanks again for the responses!
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Old 11-27-2020, 10:19 AM   #13
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"One important caveat is the difference in treatment if someone other than the parents or student—such as a grandparent—owns the 529 plan. In that case, while these 529 savings are not reported as a student asset on the Free Application for Federal Student Aid (FAFSA), any distribution from this 529 plan is reported as income to the beneficiary, potentially resulting in a significant reduction in eligibility for need-based aid the following year."
Our oldest GS held off on using the 529 until his final semesters in part because of this, and also to let the value increase.
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Old 11-27-2020, 11:02 AM   #14
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I appreciate all the responses, but what levindb describes above is why we are considering the UTMA over the 529. Here in California I believe there are no front end tax advantages in usng the 529 (e.g., there is no state tax deduction for contributions to the 529), but of course there is the back end advantage of tax free growth if used for education, which is the ultimate purpose of $$$ gifted to our young grandchildren.

But now I am thinking maybe we can gift our appreciated stock to an UTMA in the names of our grandchildren, and encourage the custodians (i.e., our adult children) to sell it and reinvest it in the 529s they have set up for the grandchildren. That would give tax advantages at both the back and the front end. But would need a financial advisor, I guess, to tell us if this is legit.

Anyways, thanks again for the responses!
It's an interesting idea to transfer funds from an UTMA to a 529. At first I thought that shouldn't be possible because the UTMA is owned by the child while the 529 is owned by the parent, and the beneficiary of the 529 can be changed, thus creating a pathway to steal from the child. But, I did a little googling, and apparently it is allowed and is even recommended in some cases.

https://www.merrilledge.com/ask/coll...from-529-plans

Quote:
You can move money from a custodial account, such as an UGMA (Uniform Gifts to Minors Act) or an UTMA (Uniform Transfers to Minors Act), to a 529 plan. But you can't do the reverse — transfer or convert from a 529 to a custodial account — without adverse tax consequences.
If the parents do sell the stock for the children, then each child who has a gain over $1100 will have to file a separate tax return. If the gain is over $2200, then they'll also owe kiddie tax. This type of income can't be included on the parents' return, so there's some extra paperwork (and expense, if they pay to have their returns done) for the parents.
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Old 11-27-2020, 11:58 AM   #15
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We have an edu program. Put in up to $2500 per year and the Gov't will match your amount up $500 or 20 percent. Can do this for 18 years I believe. All fund inside the program grow tax free. The Govenement match amounts are taxed in the hands of the student when withdrawn but are offset by tuitions, etc for tax purposes.

We have done this for each of our grandchildren since birth. BUT....the cost of post secondary education is increasing muc, much faster than the rate of inflation.

One of the terms in our wills is that the first $100K off the top goes to each grandchild in trust for their post secondary education. Before anything passes to our children. It is a gift that we believe will go on giving long after we are gone. We plan to review this amount every five years or so when we renew our respective wills.
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Old 11-27-2020, 01:14 PM   #16
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It's an interesting idea to transfer funds from an UTMA to a 529. At first I thought that shouldn't be possible because the UTMA is owned by the child while the 529 is owned by the parent, and the beneficiary of the 529 can be changed, thus creating a pathway to steal from the child. But, I did a little googling, and apparently it is allowed and is even recommended in some cases.

https://www.merrilledge.com/ask/coll...from-529-plans

If the parents do sell the stock for the children, then each child who has a gain over $1100 will have to file a separate tax return. If the gain is over $2200, then they'll also owe kiddie tax. This type of income can't be included on the parents' return, so there's some extra paperwork (and expense, if they pay to have their returns done) for the parents.
Thanks! Will definitely follow up on this now.
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Old 11-27-2020, 02:04 PM   #17
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[QUOTE=ITTN;2517816]"One important caveat is the difference in treatment if someone other than the parents or student—such as a grandparent—owns the 529 plan. In that case, while these 529 savings are not reported as a student asset on the Free Application for Federal Student Aid (FAFSA), any distribution from this 529 plan is reported as income to the beneficiary, potentially resulting in a significant reduction in eligibility for need-based aid the following year."

Our plans for our 5 GK's are attempting to incorporate this factor regarding FAFSA. We fund the 529 to the point that it will cover the final year of education. This takes it out of the FAFSA equation for the first few years. Furthermore it provides incentive for the kid to make it to the final year.
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