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What to Use First: a 529 Plan or UTMA?

Howard Hook, CFP®, CPA, quoted in NJMoneyHelp on January 21, 2015

The Question: I’ve saved money for my kids in a 529 Plan, but before those were popular, I saved in an UTMA account. My son is a junior and I’ve heard that UTMAs can hurt when it comes to financial aid. Is that true, and how to I decide which money to use first?

The Answer: Glad to hear you’re planning ahead for those college bills.

UTMAs — Uniform Transfer To Minor Act accounts — do have a harsher impact on the federal financial aid calculation relative to 529 Plans, said Brian Kazanchy, a certified financial planner with RegentAtlantic Capital in Morristown.

In determining eligibility for aid, the Department of Education calculates an Expected Family Contribution (EFC).

“The calculation shows how much the parents and student are expected to pay for school from their income and savings,” Kazanchy said. “Twenty percent of all UTMA assets are included in the EFC. In comparison, for a 529 Plan with the parent as the owner and the student as the beneficiary, only 5.64 percent of the assets are included in the EFC.”

You should also consider taxes when it comes to the UTMA.

“Earnings from the UTMA accounts are taxed and depending upon how large, the earnings may be taxed at the parent’s marginal tax rate,” said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton. “529 plans, on the other hand, if used for qualified higher education expenses, are tax-free when distributed.”

Hook said this tax benefit creates a potentially large advantage to use the 529 plan account for college expenses.

This while the UTMA money doesn’t have to be used for college. It can be used for any non-parental obligations for the benefit of the child, such as a laptop, SAT class tuition, and more.

From a financial aid standpoint, Hook said you have several options, including liquidating the UTMA funds into a 529 Plan.

“There may be taxes owed on the liquidation which could be considerable and thus it may not be appropriate to do,” he said. “In addition, liquidating the UTMA in the year prior to the child going to college may not work because the income would appear as the child’s income on their tax return.”

Another way would be to spend down the UTMA assets on non-parental obligations for the minor child, and then replace those funds spent with your own assets in a custodial 529 plan, Hook said.

If you need to use the UTMA funds for college expenses, Kazanchy recommends using them first.

“This could help your financial aid eligibility in years two, three and four of college — or any additional schooling later on,” he said. “In addition, the growth of 529 assets is tax-free making, them a superior savings vehicle to keep invested longer.”