Q. I’ve been thinking about changing my oldest son’s custodial account to a 529 plan. Is there any reason to ask my parents to donate to the 529 plan versus the custodial account?
A. Yes there is a good reason to redirect the gift, a 529 plan funded with money from a custodial account eliminates the ability for you to change beneficiaries. A 529 plan funded with non-custodial money would allow you to transfer the funds to another family member if your oldest son decides not to attend college or better yet gets a full scholarship! If you intend to transfer your son’s custodian account to a 529 plan, which I think is a good idea; you should start a separate 529 plan with any “new” money. The account funded with non-custodial money would allow you to change the beneficiary.
I don’t know why anyone would have a Uniform Gift to Minor Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account, the tax law change has made them very unattractive. These custodian accounts for minors no longer allow unearned income of children age 14 or over to be taxed at the typically lower children’s tax rate. Under the new tax law, unearned income of more than $2,000 of children under age 18 will be taxed at the parent’s rate. Once a son or daughter turns 18, the investment income will be taxed at the child’s rate. If the “child” is a full-time student age 23 and younger, taxes owed from these accounts will be at the parent’s tax rate. Students age 19 to 23 will be exempt from this requirement if they are earning income totaling more than half of their support.
Under current law, assets in a 529 plan owned by the parent with the child as beneficiary are counted as the parent’s asset for purposes of calculating financial aid and assets in a custodial account are counted as the child’s asset. Having assets in the parent’s name versus the child’s can be a significant advantage when applying for aid.
Another advantage of moving the money from the custodial accounts to a 529 plan is the tax savings when the money is withdrawn. All withdrawals from 529 plans are tax free when used for qualifying college costs. If the market continues to rise before you begin withdrawals from your son’s plan, the gains on the 529 investments will not be taxed.
Several good options
Many 529 plans change the investment mix of the account from stocks to more conservative investments as the beneficiary nears college age. There are some plans, including the NC plan that offer static investment options. You can change your investment options once a year. New money can be directed to any of the static or non-static investments.
The NC plan has added some very good low cost investments with risks ranging from very conservative to aggressive. No-load fund giant Vanguard offers many good low cost investments in the plan. Year to date as of 10-31-13, the after expense annual return for the funds offered ranged from -1.47 (bonds) to 22.29 (all stocks). The moderate allocation has a 9.92 rate of return. Currently the plan allows for a state tax deduction for plan contributions. A married couple can deduct up to $5,000 and a single filer can deduct up to $2,500. Depending on your tax bracket, you could save 7 to 8.25 percent. A married couple contributing $5,000 would save between $350 and $415.50. This deduction is going away next year. Legislation enacted by the North Carolina General Assembly (G.S. statute 105-134.6) which will go into effect January 1, 2014 repeals the NC 529 state tax deduction on contributions. To get the deduction, contributions need to be made before the end of this year. There are deadlines so check them out and apply at www.cfnc.org or call 1-800-600-3453 for information.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624