My twin daughters will be entering college in the fall. We have
saved for their college education over the last 17 years. Presently
the savings are held in two accounts each: a custodial account under
the Uniform Transfer to Minor Act (UTMA) and in a Coverdell Education
IRA account. I recently read that in connection with evaluating any
possible financial aid (and in determining the EFC) that it was
beneficial for their assets to be held in a Section 529 plan rather
than a custodial UTMA account. Is this true? Since these funds are
truly their assets (as a result of previous gifts from ourselves and
other family members) can I, as the custodian of these accounts,
transfer their funds to a Section 529 plan in each of their respective
names? Or does it remain a custodial account until they are 18? Is
it worthwhile to make this transfer? How much difference will it make
in the calculation of the EFC if the assets are held in a 529 plan
versus a custodial savings account in their name? I do not understand
why it should make any difference. It is essential that these funds
remain very conservatively invested since our daughters are soon to be
entering freshman. Are there any particular 529 plans that you would
recommend we look at that we can be certain that the funds remain
intact and available for paying college expenses?
— Karen G.
Student assets are assessed more heavily than parent assets on the
Free Application for Federal Student Aid (FAFSA).
Most parent assets are sheltered on the FAFSA. Money in qualified
retirement plans, life insurance policies, the net worth of the
principal place of residence and any small businesses owned and
controlled by the family are not reported as assets on the FAFSA.
There is also an age-based asset protection allowance based on the age
of the older parent that typically shelters an additional $50,000 or
so in assets. If the parents' adjusted gross income (AGI) is less than
$50,000 and the parents are eligible to file an IRS Form 1040A or
1040EZ (or the parents satisfy certain other criteria) then the
simplified needs test will disregard all assets reported on the FAFSA.
Less than 4% of dependent students have any contribution from parent
assets as part of their EFC. Of those that do have a contribution from
parent assets, the amount of the contribution is based on a bracketed
system with a top bracket of 5.64%. Thus in a worst case scenario
every $10,000 saved in the parent's name will increase the EFC by
Student assets, on the other hand, do not have an asset protection
allowance and are assessed at a flat rate of 20%. Every $10,000 saved
in the student's name will increase the EFC by $2,000.
A custodial UTMA account is reported as the student's asset on the
FAFSA. A 529 college savings plan for a dependent student beneficiary
is reported as the parents' asset on the FAFSA, even if the account is
owned by the student (i.e., a custodial 529 college savings
plan). This favorable treatment of 529 college savings plans became
effective with the 2009-10 academic year. (Congress enacted the change
as part of the College Cost Reduction and Access Act of 2007.) Thus
moving the money from a custodial UTMA account to a custodial 529
college savings plan account will reduce the EFC by at least 14.36%
(20% - 5.64%) of the value of the account. That's $1,436 in additional
aid eligibility for every $10,000 of college savings.
The Coverdell Education Savings Account, formerly known as an
Education IRA, has the same impact on financial aid eligibility as a
529 college savings plan.
(About 250 colleges use the CSS/Financial Aid PROFILE Form for
allocating their own financial aid funds. They still use the federal
EFC to award federal and state student aid funds. The PROFILE treats a
529 plan as a student asset if the student is named as a beneficiary
regardless of whether the account is owned by the student or a
parent. The PROFILE also considers the net worth of the family home,
but caps it at 2-3 times the parents' income.)
You can transfer the money from the UTMA or other custodial accounts to
a 529 college savings plan. Since the money comes from an UTMA
account, you must set up a custodial 529 college savings plan account,
as opposed to a regular 529 plan account. The custodial 529 plan will
be titled the same as the UTMA account. As custodian you will not be
permitted to change the beneficiary of the custodial 529 plan. When
the child reaches the age of trust termination — age 18 or 21,
depending on the state — he or she will become the account owner
of the section 529 plan.
All 529 college savings plans have conservative investment options,
such as money market accounts and US Treasuries. Some even include
certificates of deposit as investment options. All also offer an
age-based asset allocation option, but you should verify that it
bottoms out with no more than 20% of the funds invested in stocks or
other risky investments when college is less than a year or two
away. The rest of the money should be invested in funds where there is
no risk of loss to principal.
Generally, you should invest in the state 529 college savings plan
with the lowest fees, such as one run by Fidelity, Vanguard or
TIAA-CREF. Use the direct-sold version, not the adviser-sold version,
as the direct-sold versions have lower fees. All else being equal,
pick your own state's plan if it offers a
state income-tax deduction on contributions to the state's 529 plan
The District of Columbia and 34 states offer such a state income tax
deduction. Seven states do not have a state income tax.
Of the states with a state income tax, only California, Delaware,
Hawaii, Kentucky, Massachusetts, Minnesota, New Hampshire, New Jersey
and Tennessee do not offer a state income tax deduction for 529 plan
You are correct that it does not make sense for student and parent
assets to be treated differently. After all, student assets usually
come from the parents. In fact, it does not make sense for the FAFSA
to consider assets at all. Less than 1% of parents with just one child
in college, more than $10,000 in investment assets and at least
$50,000 in adjusted gross income qualified for a Pell Grant in
2007-08. Parents who have enough assets to affect eligibility for
need-based financial aid usually have enough income to lose
eligibility without regard to the assets. But current law requires
student and parent assets to be reported on the FAFSA.
The tax advantages of 529 college savings plans and the favorable
treatment by federal need analysis formulas make them one of the best
options for saving for college.