Is this a stupid idea?

[SecondCor521]

Background: I have three kids, age 12, 7, and 5, and I plan to pay for four years of tuition/room/board/books for each of them. Each kid has three accounts which contain their college money -- a 529, a UTMA, and an ESA. If my math is right, the 12 year old and the 7 year old are now fully funded. The 5 year old still needs an additional $5K worth of funding in today's dollars.

I am considering the following action:

1. Sell from their UTMA accounts in December. This will realize some capital gains, which, as I understand it, will be taxed at 5% if I keep the gains under $1700 per child.
2. Take the proceeds and reinvest in the 529 plans and the ESA's in January. I get a state tax deduction for a max of $4k of the 529 contributions. My state marginal rate is 7.8%.

This seems to be a no-brainer for the first $4k I do this with because of the tax deduction. Anything above that number, I am voluntarily paying some capital gains now. Paying these capital gains reduces the amount that my kids have access to when they reach the age of majority on the off chance they decide to blow it on a Mustang or something. It also moves the money into accounts that are more easily transferable between the three kids as opposed to money that is specifically for a specific child. Finally, if I repeated this trick yearly I could probably drain their UTMA accounts and simplify my life a little with just six college accounts instead of nine.

I am cautious because in general I have a bias for deferring paying taxes. I am also curious if I am overlooking anything.

I understand that withdrawals from UTMA accounts need to be for the benefit of the children. I believe that my child support payments qualify under the law for this purpose; my state child support guidelines written by my state supreme court explicitly state at one point that the child support payments are for the benefit of the children. Therefore I would be able to withdraw the equivalent of up to four months worth of child support payments from each UTMA (12 months in 2007 / 3 kids). In actuality I am paying the child support payments out of current cash flow, but I believe this meets the letter and spirit of the law. I know some will disagree that UTMA account assets cannot be used for basic support needs but I have researched this point as well and believe this is not the case.

Feedback welcome, both on the UTMA legality aspect as well as the wisdom or foolishness of the overall idea.

2Cor521

 

[Getting short]

I cashed out my kid's UTMAs and invested the money in 529s. I documented that I used the money for basic support, both my accountant and FA said that it was totally legal and within the spirit of the law.

Having the money in your name (529) rather than your child's (UTMA) will help you with FAFSA as the % of assets they expect you to pay is less than the student's and because withdrawals will not count as income the following year.

The only drawback is that you are bound to use the 529 money for educational expenses or suffer the 10% penalty. My oldest just started college, on a full scholarship. However, she is anticipating professional school (med or architecture), so it is likely that she will still use the money. Plus there is her little sister and the fact that I only have about half of the necessary amount in 529s, the rest is in taxable accounts.

 

[RunningBum]

Somewhere I read that if you transfer a UTMA to a 529 you still have to treat the money with the UTMA rules, including listing it under your child's assets on FAFSA. I don't remember where I saw that though.

 

[Nords]

UTMAs were around long before 529s were created, and I bet the use of UTMAs has dropped dramatically since 529s have become more effective college-savings programs.

Of course, as has been pointed out, the 529 penalizes using the money for starting a business or making a downpayment on a home or anything other than giving it to the college authorities. Seems like a pretty narrow definition of "educational".

We've talked about cashing out our kid's UTMA in 2007/8 to avoid a big FAFSA impact on 2009's tax returns (she graduates high school in 2010) but it seems like an awful lot of financial engineering for a little bit of needs-based scholarship money-- effort that might be better devoted to achieving higher SAT scores & merit-based money. I also think that the kid's itty-bitty UTMA will have far less of an effect on her needs-based money than the parent's comparatively larger ER portfolio will have on getting financial aid.

I've never heard of anyone getting in legal trouble with a UTMA.

 

[SecondCor521]

Thanks all.

getting short, I have some plans to avoid the "extra $" penalty. First, the largest 529 has the eldest child as the beneficiary. As we go through I plan to roll that down from child to child. If there is still some left after my youngest graduates, I can roll it to younger cousins or tell my kids to use it as seed money for their kids.

RunningBum, what you say is correct. But I am not talking about a direct transfer from the UTMA to the 529. I am doing a two step process of taking cash out of the UTMA and depositing it into my checking account (to reimburse me for paying child support). I am then turning around and making a contribution from my checking account to the 529 plan.

Nords, yep, the UTMA's are sort of left over accounts that were started when my kids were little, 529's hadn't been invented yet, and ESA's had that stupid $500 per year limit. I want to balance the flexibility of how you can use the money from a UTMA against the extra flexibility the kid has to take the money out and the inflexibility that the money has to be used on that kid.

FAFSA is actually a secondary concern but the benefit there is just one more reason for me to do this.

By the by, Nords, doesn't FAFSA ignore parents' IRA's and home equity? I haven't studied it much, preferring to treat finaid like SS -- don't plan on it but if I get some it's gravy.

2Cor521

 

[RunningBum]

FinAid | Calculators | Expected Family Contribution (EFC) and Financial Aid is an online calculator you can run to get an estimate, and I think you can see from here what is protected.

I don't have a very good idea of how my daughter will come out since I'm not the custodial parent, but going the UTMA route (I put a pretty big chunk in before 529s came to be) probably will mess her up. Also I'm not clear if they'll look at me too. My impression is that they will, and that will finish her.

 

[FinanceDude]

Somewhere I read that if you transfer a UTMA to a 529 you still have to treat the money with the UTMA rules, including listing it under your child's assets on FAFSA. I don't remember where I saw that though.

That's not true, you can treat it as 529 assets whether it came from an UTMA or not. However, the 529 plan provider has to make you sign saying that the monies were from an UTMA, and you will follow those guidelines,like letting the child know it's their money, etc...........

 

[Getting short]

SecondCor, that's pretty much the same plan I have if the money isn't used up in the first go round. Not to mention using the 529 to pay me to take courses in Europe (saw an interesting thread on the boggleheads board about that).

FAFSA does ignore retirement accounts (as assets, they do count what you put in during the current year as income) and home equity. However, Profile schools usually use home equity and do ask about retirement accounts (I'm not sure how each school deals with that information). While FAFSA is pretty cut and dry, Profile schools do rely on "professional judgement" when giving a FA package. And packages are often negotiable if the student gets a better FA offer from a peer or higher school. Our FA packages differed by as much as 20k/yr, and a couple of schools matched the better offers when we asked for a review. One school actually told us that they decided not to count our home equity when they reevaluated our award.

RunningBum, I'm afraid that the finances of both parents are considered for FA. But you never know, I ran several FA calculators and most said that we had little to no need. In the end, some schools agreed with that assessment, but a few gave us a substantial amount of FA. However, the ones that offered money also had some of the highest endowments in the country .

Nords, yeah, my D ended up going with the merit scholarship and is actually "making" money this year due to receiving some outside scholarships as well. She worked her bu** off for four years, but it paid off with lots of excellent choices last spring.

 

[Nords]

By the by, Nords, doesn't FAFSA ignore parents' IRA's and home equity? I haven't studied it much, preferring to treat finaid like SS -- don't plan on it but if I get some it's gravy.

That's right.

The bulk of our ER assets are in taxable accounts, so our kid is going to have to go for the merit money.

 

[haha]

Feedback welcome, both on the UTMA legality aspect as well as the wisdom or foolishness of the overall idea.
2Cor521

I don't know anything about college savings plans; thank God I never had to pay any attention to that kind of thing. But to me, a key point for a non-custodial parent is maximum leverage with your kids and maximum enjoyment for you out of what is clearly a limited resource- your money. The custodial parent will often be working to poison their minds against you anyway, so what you want is to get the most from your modest resources. I'd make no formal plans to pay tuition- who knows, by the time they grow to age 18 you may be retired and living in the Philippines with a beautiful young woman. You will be safely out of reach of your ex's grasp, and you can choose to pay out whatever you want to your kids, whenever and however you wish.

Ha

 

[SecondCor521]

I don't know anything about college savings plans; thank God I never had to pay any attention to that kind of thing. But to me, a key point for a non-custodial parent is maximum leverage with your kids and maximum enjoyment for you out of what is clearly a limited resource- your money. The custodial parent will often be working to poison their minds against you anyway, so what you want is to get the most from your modest resources. I'd make no formal plans to pay tuition- who knows, by the time they grow to age 18 you may be retired and living in the Philippines with a beautiful young woman. You will be safely out of reach of your ex's grasp, and you can choose to pay out whatever you want to your kids, whenever and however you wish.

Ha

Good advice, ha.

With respect to divorce in my state, the state considers the kids emancipated at 19 or when they finish high school, whichever comes first (my three will all turn 18 their senior year in high school). So the state could care less. My ex said she'll contribute what she can but no guarantees, which I've mentally translated as "zero". So after some thinking I decided *I* want my kids to go to college, so *I'll* pay for it as best I can. I believe at some point, provided I raise 'em right, they'll be grateful. My college was paid for via a combination of merit scholarships, ROTC service, and my parents. I appreciate that very much now and want to pay it forward to the next generation.

Keeping the money in 529's and ESA's will help me pay out what I wish when I wish, too.

2Cor521