UTMA to 529: Quest for Control
By Kaye A. Thomas
Current as of July 8, 2016
The rules for 529 accounts give strong control to the adult owner. But do they trump the UTMA rules?
Sometimes the motivation that leads people to consider moving a custodial account under the Uniform Transfers to Minors Act to a 529 account is a desire for greater control. If we compare the general rules for the two types of accounts we learn the following:
- Control of a UTMA account passes to the minor at a specified age, usually 18 or 21. Control of a 529 account remains with the owner without regard to the age of the beneficiary.
- The owner of a 529 account can change the beneficiary designation, making it possible for the account to cover the college expenses of a sibling or other relative of the original beneficiary. The custodian of a UTMA account is not allowed to change the beneficiary.
- And that’s not all. It’s perfectly legal for the owner of a 529 to withdraw some or all of the funds for his or her own purposes. The owner will pay tax and penalty on the part of the withdrawal representing investment earnings, but recovers full control of the funds. Any funds withdrawn from a UTMA account, unless moved to another UTMA account set up for the same minor, must be given to the minor or spent for the minor’s benefit.
When it matters
The superior level of control retained by owners of 529 accounts can be helpful in various types of situations. The child may lack the maturity to handle money properly at the time control of a UTMA account would pass. If the UTMA was intended to cover college expenses, but the child doesn’t go to college, or wins a full scholarship, it won’t be used for its original purpose and might be better directed elsewhere, such as a sibling’s college expenses. Sometimes the parents simply have an extraordinary financial need that overrides the desire to preserve these funds for the beneficiary’s education. In any of these cases, the custodian of a UTMA account may look with envy at the 529 account owner’s nearly complete control over the funds.
UTMA controls persist
Unfortunately, transferring a UTMA account to a 529 account solves none of these problems. When you make this move, you’re creating a special kind of 529 account: a custodial 529 account. All the rules that apply to a regular UTMA account continue to apply. The custodian can’t recover the funds for his or her own use, and can’t change the beneficiary. Control of the account passes to the minor at the same age as would have been the case for the UTMA account.
The key point here is that placing money in a 529 account does not change the owner of that money. Usually a parent or other relative contributes his or her own money and is considered the owner of the 529 account. Funds in a UTMA account are owned by the minor, and that means the minor is the owner of any 529 account that receives those funds.
Most 529 plans, if not all, have procedures for setting up a custodial 529 account. Generally they impose rules that are appropriate in light of the beneficiary’s ownership of the account, such as prohibiting any change in beneficiary. These controls are simply a recognition of what the law requires for UTMA accounts.
You may be able to avoid these direct controls by taking money from the UTMA account and then contributing it to a 529 account without informing the provider of the 529 plan that these are custodial funds. Doing so would be a violation of the Uniform Transfers to Minors Act, however. UTMA’s restrictions continue in force until the funds are expended for the benefit of the minor or turned over to the minor’s control. The UTMA rules trump the 529 rules, not the other way around.
In some situations, transferring UTMA funds to a 529 account may prove beneficial. Having the money in an account specifically intended to cover college costs may discourage the minor from seeking to use it for a different purpose, particularly if he or she is aware that a penalty will apply to account earnings that are not used for qualified expenses. Such considerations may not seem likely to be effective in preventing a young adult from abusing the account, but sometimes a nudge in the right direction is all that’s needed.
Generally, though, the primary benefits in moving the account come the student financial aid formula and, in some cases, the tax rules.