Who owns an asset – meaning the child, the parent, a grandparent or some other wealthy benefactor – can significantly impact how much of that asset a college’s financial aid office expects you to contribute to paying college costs. Let’s explore how and why.
Say you’ve saved $100,000 for your child’s college education by the time she’s a high school senior.
Assets that are considered to be owned by you, the parent, are assessed at 5.64%. This will include funds held by you in checking, savings and traditional/taxable brokerage accounts, and – good news – 529 plans, even if they are nominally owned by your child. Of that $100,000 you’ve saved, a college will expect that $5,640 be used to pay for college each year.
On the other hand, assets that are considered to be owned by the child – like funds held in an UGMA/UTMA – are assessed at a much higher rate – 20%. Of that same $100,000 saved in an UGMA/UTMA, a college will expect you to use $20,000 each year to pay for college.
Can you see what just happened here? The decision about where to save that $100,000 for college – in an UGMA/UTMA v. a 529, just raised your family’s expected contribution, or EFC, by $14,360 each year.
You’re first reaction is probably something along the lines of “No one ever told me….” There’s likely a good reason for that.
For those who’ve been working with a financial advisor
The typical financial advisor is operating under a business model where they make a percentage – usually 1% – of the assets that they’re managing. Since 529 plans are administered by institutional money managers like Vanguard or TIAA-CREFF, a financial advisor can’t profit from them. Savings placed in UGMA/UTMAs, on the other hand, can be included in an advisor’s managed assets, on which s/he earns fees.
Your financial advisor may have told you that 529 plan fees were high, investment plan choices were limited and performance v. traditional mutual funds was difficult to determine. And all of that was quite true in the early days of 529 plans – the late 1990’s and early 2000’s. (Hint: It hasn’t been true for the last decade.)
Your tax professional may have doubled-down on your financial advisor’s advice, since UGMA/UTMAs once enjoyed some beneficial tax treatment.
For those who were “do-it-yourselfers”
You’re off the hook. The financial press was largely echoing the advice that financial advisors and tax professionals were giving. (Hmm, could there be some relationship between what the financial press is touting and what financial advisors are selling? But I digress….)
What to do now
So you got some bad advice. What can you do now?
Changes to the tax code made in late 2017 severely limited the already small tax advantages given to savings held in an UGMA/UTMA. Greater competition for 529 plan assets over the last decade means that
- fees have come down drastically, to where a plan using index funds charges about 0.13% in fees;
- investment options are as broad as they can be; and,
- performance is transparent.
If you have saved funds in a UGMA/UTMA, all is not lost! You can liquidate the assets held and transfer the cash into a Custodial 529 account that will, ultimately, be considered an asset of the parent for financial aid purposes. You will have to pay tax on capital gains in the UGMA/UTMA, but the savings in financial aid granted should well exceed those taxes.
Next, we’ll explore how you can shelter more college savings in accounts held by grandparents or other wealthy benefactors.