Question: My parents set up UTMA and 529 College Savings accounts for my children. I am not sure exactly what effect these accounts have on their financial aid in the future or whose assets they are if my parents need nursing home care.
Answer: UTMA, or the Uniform Transfer to Minors Act are custodial accounts that are set up by an adult on behalf of a minor. All the money and assets in these types of accounts are turned over to the beneficiary’s control at the age of 21. Once the beneficiary reaches age 21, they can use the funds in any way they choose regardless of your expectations on how the funds should be spent.
UTMA accounts are typically held at a banks, mutual fund companies or brokerage houses. They are often the first form of savings that many parents and grandparents set up for young children. Likewise, when buying savings bonds for children, it’s necessary to designate a custodian. Though technically minors are the sole beneficiary of the assets, they are not allowed to exercise ownership rights because legally they cannot enter into binding contracts.
A UTMA account cannot be used to pay for support obligations (food, clothing and shelter), since parents are obligated to pay for those expenses. The funds in an UTMA account could be used to defray the costs of the college application process. If your child decides to and enroll in a vocational program after high school, as long as the program is accredited, the funds in the UTMA account could be used for those costs. However, this could decrease the financial aid the student would otherwise be entitled to receive. Earnings on money in an UTMA account are subject to income tax. Depending on the value of the account and the income tax bracket of the parents, these UTMA accounts could have negative income tax implications for the family.
In contrast, a 529 college savings plan offers income tax savings. If you put money in a 529 plan, you do not have to pay federal or state income tax on the earnings, provided the account is used to pay for college expenses. So given a choice about whether to contribute to an UTMA or a 529 plan, a 529 plan may be a better choice, especially if the intention is that those funds are to be used for college.
When gifting, be mindful of the annual gift tax exemption of $15,000 per year per person (2021). In addition, if you are the custodian on an account, verify that there is an alternate or successor custodian in place in case something happens to you. Beware the pitfalls of being the custodian of an account. If you later need Medicaid, any monies held in a 529 plan in which you or your spouse are a custodian would be deemed an available asset for Medicaid purposes. Furthermore, any payments from the 529 plan for college expenses within five years of applying for Medicaid could be deemed a transfer that makes you ineligible. It would be better to have a Trust named as custodian of the account or someone other than the grandparent, in case Medicaid is needed in the future.
Do not create custodial accounts or a 529 plan for a child with special needs, as it can make them ineligible for government assistance. If a 529 plan is in place, consider changing the beneficiary to another child in the family.
UTMA and 529 accounts, while usually established with the love and best of intentions of a grandparent, can have unintended consequences. In many cases, it would be far better to create a trust for the minor which would not interfere with financial aid or be deemed an available asset if the grandparent needs Medicaid to pay for long term care.