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College Planning Q&A: UTMA Funds and Coverdells

Plus, grandparent Coverdell contributions and more.

Susan T. Bart, 10/24/2008

College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to advisorquest@morningstar.com.

Question: Is it permissible to use UTMA funds to contribute to a Coverdell ESA?
Susan: Not to my knowledge. This may violate the custodian's duties under the Uniform Transfers to Minors Act because the responsible person for the Coverdell education savings account may change the beneficiary. When UTMA funds are placed in a 529 savings account, the account owner cannot subsequently change the beneficiary.

Question: Along those same lines, can a grandparent gift directly into the Coverdell where the parent is listed as the owner/contributor?
Susan: Yes, but total annual contributions to all Coverdell Education Savings Accounts for a particular beneficiary cannot exceed $2,000 per year.

Question: We have a client who has a UTMA 529 plan for his son. This client's tax advisor has told him that he can keep the funds in the plan while the son is in college and distribute the funds at the end of college. The goal is to keep the money growing as long as possible. We have not been able to find any literature on this strategy and would appreciate your insight.
Susan: The custodian under the UTMA must distribute the UTMA assets to the son at the statutory age (age 21 in most states for assets gifted to a UTMA account). Where the custodian has placed the UTMA assets in a 529 savings account, the custodian could fulfill his or her fiduciary duties by changing the account owner to the son.

Question: Is it possible to have a testamentary devise go straight to a 529 plan where the 529 plan is owned by an individual? I don't see any reason that it could not, but I am not very experienced with 529 plans and I could not find a definitive answer in my research.
Susan: There's no reason that it could not, although if the gift was specifically to the 529 account there may be a question of what happens if the account is not in existence. It may be preferable to make the gift to the beneficiary, but grant the executor the power to distribute it to a 529 account or to a UTMA account for the beneficiary if appropriate.

Scott Anderson, President of College Financial Strategies, Davenport, Iowa, wrote to explain some nuances of the financial aid regulations with which I was not familiar:
"Just wanted to give you a little feedback on the first question (in the August MorningstarAdvisor) about moving a 529 to an LLC. I do agree with you that it would not likely be worth the hassle of moving the 529 to the LLC, but your concern over the LLC's impact on any financial aid needs no worry. There was a change in the financial aid regulations last year which exempts small businesses (less than 100 employees) from any FAFSA calculations. This gives small business owners a tremendous amount of flexibility in the financial aid process. While technically moving the 529 to the business would exempt the 529 from consideration, it seems a little too gray. However, small businesses are great financial aid shelters for other parent assets such as dormant cash."

To comply with certain Treasury regulations, we state that (i) this article is written to support the promotion and marketing of the transactions or matters addressed herein, (ii) this article is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (iii) each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

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