Definition, Pros & Cons vs. Traditional 529

What Is an UGMA/UTMA 529 Plan?

An UGMA/UTMA 529 plan is a custodial 529 college savings plan account funded with money from an existing Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account. It differs from a traditional 529 plan in several important respects.

How UGMA/UTMA 529 Plans Work

Before the introduction of state-run 529 college savings plans, many parents invested for their children’s education and other major financial goals through Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) custodial accounts. The two types of account are very similar, although a UTMA account can hold a wider range of investments, including real estate and fine art.

When states began rolling out 529 college savings plans in the 1980s and ’90s, UGMA and UTMA accounts lost much of their appeal for college savers. The new 529 plans offered a number of tax advantages that UGMA and UTMA accounts didn’t, including state tax breaks for contributions in many states and no federal taxes on earnings or withdrawals, so long as the money in the plan was used for qualified educational expenses. UGMA and UTMA accounts still exist, but people who use them today are likely to have goals other than paying for college in mind.

For families with college-bound children and money in an existing UGMA or UTMA account, it’s possible to move that money into a UGMA/UTMA 529 custodial account. But is it a good idea?

Pros and Cons of UGMA/UTMA 529 Plans

If you’re considering switching from an UGMA or UTMA account to one of these special 529 plan accounts, here are some of the pros and cons to consider:

Pro: You Could Get a Break on Financial Aid

In typical financial aid formulas, money held in a child’s name, as with an UGMA or UTMA account, is more likely to reduce your aid eligibility than money held in a parent’s name—as is the case for 529 accounts. And even though a custodial 529 technically belongs to the child, it’s considered a parental asset for financial aid purposes.

Con: You’ll Lose Some Flexibility

Money in an UGMA or UTMA account can be used for any purpose as long as it is for the benefit of the child whose name is on the account. For example, if a child needs orthodontia, then that money is available.

With a 529 plan, however, money that isn’t used for qualified educational expenses—which include tuition, room and board, and required fees—incurs taxes and penalties. The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed and signed into law in 2019, expanded the law to also allow for tax-free withdrawals of up to $10,000 per lifetime to repay qualified student loans.

The SECURE 2.0 Act of 2022 allowed even greater flexibility, permitting up to $35,000, per lifetime, of a 529 to be converted to a Roth individual retirement account (IRA) in the name of the beneficiary. The account must be open for 15 years to qualify for a Roth conversion and must be transferred in accordance with annual contribution limits.

What’s more, unlike the money in a traditional 529 plan, money in an UGMA/UTMA 529 plan can only be used for the qualified educational expenses of that particular child and can’t be transferred to a sibling or other family member.

Pro: You’ll Maintain Some Control

The money in UGMA and UTMA accounts belongs to the child. A parent or other adult serves as custodian and, as mentioned, can use that money for the child’s benefit. However, when the child reaches a certain age—typically 18 to 25—the money is theirs to do with as they please. That might mean paying for college, making the down payment on a first home, or spending it all on a trip to Hawaii. It’s entirely the child’s call.

With a 529 plan, on the other hand, the money has to be used for educational expenses. Otherwise, it’s subject to both taxes and penalties. In that way, opening an UGMA/UTMA 529 plan provides at least some assurance that the money will be put to a good purpose.

Con: You’ll Face a Tax Bill

To move your money from an UGMA or UTMA account into a 529 plan, you’ll have to liquidate those assets. That means your child will incur income taxes on any untaxed appreciation or earnings in the account.

If the account was invested in mutual funds, for example, then you or your child have probably been paying tax on your account’s dividends and capital gains distributions every year, so you may not owe all that much. However, if your account was invested in real estate or some other asset that has appreciated but not spun off taxable income every year, then you could be in for a substantial bill.

That said, once the money is in the 529 plan, you’ll start to enjoy some tax advantages. Any appreciation or income going forward won’t be taxable as long as the money is eventually used for qualified educational expenses. So if you’re thinking of making a switch, doing it sooner rather than later could help you make the most of the tax savings.

The Bottom Line

Moving money from an UGMA or UTMA account into an UGMA/UTMA 529 plan has some advantages, especially when it comes to financial aid. However, it will limit your flexibility in what you can spend the money on, and it may also have some negative tax implications.

Because much of the law regarding UGMA accounts, UTMA accounts, and 529 plans is state-specific, it’s a good idea to check with your state or a knowledgeable financial advisor regarding whether it allows such transfers and, if so, what its particular rules are.