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College Planning Q&A: 'Gifting' UTMA Assets

Also, answers about forced distributions, grandparent-parent transfers, and foreign ownership.

Susan T. Bart, 04/25/2008

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: Since parental assets are generally assessed only at a rate of 5.6%, compared with 35% for student-owned assets, should a parent have the student "gift" assets out of a UTMA account back to the parent before going to college?

Susan: I would not recommend such a strategy. If the beneficiary of the UTMA account is an adult (age 18 in most states) but has not yet reached the statutory age at which the UTMA account must be distributed to the beneficiary (generally age 21) the custodian is only authorized to make distributions to the beneficiary for the use and the benefit of the beneficiary. I believe that one has to stretch too far to argue that a distribution to the beneficiary for the purpose of permitting the beneficiary to make a gift is for the "use and benefit" of the beneficiary. Further, if a distribution was made to the beneficiary and the beneficiary made a gift of the assets to the parent, the normal gift tax rules would apply to the beneficiary. If the beneficiary's gifts in any year to either parent exceeded $12,000, the gift tax annual exclusion amount, the beneficiary would be making a taxable gift and would be required to file a gift tax return and report such gifts.

A better strategy might be to have the custodian invest the UTMA assets in a custodial 529 account. Because section 529 accounts for dependent students are generally treated as owned by the parent for financial aid purposes, one could then make such an argument without arguably violating the terms of the Uniform Transfers to Minors Act.

Q: My father holds a 529 account in Virginia with several thousand dollars in it that was set aside for my tuition costs. After my parents divorced two years ago, my father has refused to release any money to me to pay for college, although my mother (who supports me now) and I have made clear to him on several occasions that we are in dire need of that money and my mother cannot fully support me. Is there any way we can legally force him to release the money to pay for my tuition before I graduate? After I graduate?

Susan: There is nothing in Code section 529 that would give you any right to force your father, who presumably is the account owner of the 529 account, to make distributions from the 529 account to you for your education. Account owners under Code section 529 do not appear to owe any fiduciary duties to the beneficiary. However, divorce courts sometimes retain jurisdiction to be able to make orders regarding the payment of college education costs for the children of the marriage. Your mother might consult with her divorce attorney to see if it might be possible to get a court order directing your father to pay for a portion of your college education.

Q: I am the account owner of 529 plans for my grandchildren. As they get closer to college age, I can see advantages if one of their parents is the account owner, including much less need for me to be involved. Is there any tax consequence if I were to transfer the ownership to a parent?

Susan: Currently, under section 529 there is no immediate tax consequence to changing to a non-abusive change of account owner. However, the recently issued Advance Notice of Proposed Rulemaking on section 529 suggests that there may be a risk of adverse tax consequences in the future if you transfer ownership of the account. In the Advance Notice the IRS proposes that if an account owner distributes the 529 assets to himself or herself, the account owner will pay income taxes on the entire amount in the account except to the extent that the account owner can prove that he or she was the contributor of funds in the account. In contrast, if you, the original contributor of the funds, were still the account owner and directed a distribution to yourself, you would only be subject to income tax on the earnings portion of the account. This becomes an issue only to the extent that the funds are not distributed to the beneficiary for qualified higher education expenses. However, if there are funds left over after the beneficiary has completed the beneficiary's higher education, the income tax consequences of having an account owner who is not the original contributor could be substantial.

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