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UGMA Account and and Scholarship Question

Question:
A client has a child entering college in approximately one year. Client has money in a UGMA which could impact any assistance from a chosen school. Will moving funds into a 529 plan alleviate this worry and/or is there any other advisable way to remove the funds from the child's way at this late date?

Reply #1:
What do you think of this concept? I not sure it will work for college but a great way to control the child's UGMA after they reach 18:

If the parents were to take the UGMA and invest it in a family limited partnership (FLP) with the parent or parents as the General Partner (GP's) holding 1% of the shares and the child as the 99% Limited partner (LP), how would a college view this account since it would be difficult to calculate the value of the LP shares?

Adam A. Rothman
Senior Vice President
USICG - Executive & Professional Benefits Division

Reply #2:
If the child is a HS Junior now and will be starting college in Sept. 2003 then this year is the base year that schools use to determine financial aid. If that is the case, there is not too much that can be done. I'm assuming they will have large capital gains if you sell the UGMA assets. If so, that would create taxable income to the child. Each dollar of child-reported income over the $2300 (you should check this figure as it might have indexed higher) reduces financial aid by 50 cents. So, that would not be a good move financial aid wise.

You might consider keeping the asset until after Jan 1, 2003. Then selling part or all of it and using the money for college related expenses. This would get the realized income into the 2nd year of financial aid when the student is already in a school. The idea is to put yourself in the best position possible going into the school/student selection process prior to freshman year.

Bob Boronski

Reply #3:
Some schools will consider the 529 and some will not. Even if it is considered, the rule of thumb is that, money in the child's name is fully considered. Money in the parent's name may or may not be considered by the individual institution, but if it is, it is a percentage of total income, and most likely not 100% considered.

Each college tends to do things their own way

EGTRRA says amounts are NOT included in distributees income (hence the potential for not being included in the financial aid analysis) and contributions are not deductible. Note: this rule will change if EGTRRA Sunsets as scheduled for 2011.

Jane Warner, Esq.
Director, Advanced Planning Sun Life Financial
Phone: (800) 432-1102

Reply #4:
If you leave the money in the child's name when you fill out the financial aid forms, you will 'lose' 35 cents on the dollar in aid eligibility per year. If there aren't large capital gains, then sell the UGMA asset and move in into an annuity in the kid's name. Annuities are generally exempt from the college planning formula.

You need to explain to the client that when the money is in the annuity, any distributed gain will be taxed at ordinary income rates, and a 10 percent IRS penalty may apply to the gain. However, this could be more than offset by their increased financial aid eligibility.

Example:
$10,000 in a kid's name could cost a parent $3,500 in financial aid per year, or $14,000 over 4 years--more than the asset itself! If this money was put into an annuity and grew to $15,000, then when the child went to take it, they would pay a $500 penalty (10% of The $5000 gain), and ordinary income tax of about $750 (assuming a 15% tax bracket), so about $1,250 in total, but they might have received up to $14,000 in additional financial aid. In my opinion an excellent trade off!

As pointed out by Bob, timing of receipt of income by the child needs to be considered and planned for.

529 plans may not be the best choice because they still get counted in the formula.

Hope this helps.

Ron Caruthers
President, College Planning Specialists, Inc.

Reply #5:
First I am wondering why not use the UGMA dollars for year one and the reapply for aid once balances are LOW, but beyond that let’s look at the annuity idea.

If the UGMA is reinvested in an annuity (owned by the child), THERE IS A WAY AROUND THE 10% PENALTY!!!

IF you place funds inside of an IMMEDIATE ANNUITY there is NO 10% penalty ... You could take the funds and place it into an immediate annuity with a 5 to 7 year payout ... low annual income, no penalty, minimal taxation ...

(Moderator: While Dave is not suggesting this, be aware that you can not avoid the pre-59 ½ 10% penalty if you are moving an existing deferred annuity to an immediate annuity.)

You could even use a VA Immediate annuity to retain the similar market risk that is in the UGMA now ...

Then you only have to ascertain what the income restrictions are for different financial aid levels ...

Dave Marrone Financial Synergy, Inc

Reply #6:
If the custodian is transferring UTMA assets to a 529 Plan, the assets in the UTMA must first be liquidated, thereby resulting in a potential taxable event. Also, even if a school does not treat assets in a 529 Plan as belonging to the student, assets transferred from a UTMA probably would be treated as the student's.

Rick Petrucci
Counsel, Estate & Business Planning Dept.
Allmerica Financial
S282 440 Lincoln Street
Worcester, MA 01653
Phone: (508) 855-2442
Fax: (508) 852-0654
E-mail: rpetrucci@allmerica.com

Reply #7:
Ron,

It's true that annuities are not counted as assets for federal financial aid purposes, but this rule does not necessarily apply for a school's financial aid purposes. Also, how is the transfer of money out of a UTMA account treated for financial aid purposes?

Rick Petrucci
Counsel, Estate & Business Planning Dept.
Allmerica Financial

Reply #8:
You want to qualify for as much financial aid as possible prior to entering your first year because that is when you probably have your most leverage with the schools, especially if you have a child-student whom many schools will be attracted to. The school knows you are applying to other colleges besides them. So you may have some bargaining power. Once you are in the school you are probably not going to transfer out your sophomore year. That's why it is important to verify that financial aid will be received for all 4 years the student is at the school and not just in the first year.

That's any interesting idea on the immediate annuity. Though, depending on the amount of income received in the child's name, it could really damage financial aid eligibility. On the other hand, it could be structured such that the income is not received until after Jan 1 of the base year so that it wouldn't show up in the financial aid forms until the child's 2nd year.

Bob Boronski
Soundview Financial Associates

Reply #9:
We deal with roughly 75 college bound students each year, and we've found that most of the private colleges (the one's that might ask about annuities) generally ignore them.

Any transfer out of an UGMA will be treated as a normal liquidation. i.e. if there's a gain, the child will be taxed and that amount will be considered in the formula, and if there's been a loss, which is very common of late, it won't count. Hope this helps.

Ron Caruthers
President, College Planning Specialists, Inc.

Reply #10:
If an annuity is called for, that's fine. If it is being sold to qualify for financial aid, well that's another issue.

First, annuities are only exempt from the Federal formula; more and more schools are asking about annuities. If Harvard and Yale are asking about annuities on their financial aid forms, don't you think more and more colleges will begin to ask? Be sure the family has researched the schools their kids are likely to apply to before make a potentially drastic move. Losing 35% (to college expenses) could be better than losing 100% because you did not do your homework.

Second, if you sell the assets in the UGMA, you will have taxable income showing up on the child's 1040. How are you going to explain the capital gain? If that family (parents and child) get hit with a FAFSA Audit, you have a lot of explaining to do. Such is the capital gain income currently invested and who suggested that you do what you did with the funds?

Third, what about the tax consequences of an annuity? (Ordinary income plus early distribution penalties vs. capital gain) What about the company's surrender penalties? Are you helping or creating even more problems for the parents?

Gary Ruchin

Reply #11:
It appears that your client may be better off staying with the existing UGMA for the following reasons: If the UGMA is converted to a 529, the parent(s) would be taxed (at their attributable tax rate) on the growth of the account before it went to the 529. An advantage to converting to the 529 is that the student/child would be free of any federal income tax on the educational distributions. But is that a good trade? Parent, presumably in a higher tax bracket, is taxed on the UGMA's gain at conversion, so that student/child (presumably in a very low tax bracket), receives tax-free income for education from the 529? Something that isn't mentioned is how old the UGMA account is. Obviously if it is a relatively new account, there wouldn't be much gain to be taxed.

As to removing the funds from the child's reach: Once in the 529 plan, the "UGMA" funds are separately accounted for and do not take on all of the same attributes as other 529 funds. Ultimately, the "UGMA" funds are still an asset of the student/child, just as was the case when they were in an UGTMA.

As to school assistance, in general every higher educational institution has its own way of handling financial assistance (whether it is a scholarship, or whether a loan or grant), but most look at 529 assets as part of the overall parental pot when determining their qualification process.

Since there is only a year to go before the dollars are needed, it doesn't appear that converting to a 529 would be helpful. However, just to make sure, Manulife Financial has an UGTMA/UTMA calculator on its website. All you would have to do is type in manulife.com, go to the college savings section, find the financial planner section and sign in. It's free! The question about school assistance [UGMA vs 529] is also addressed on the website.

Peter Hutton Webster
V.P. Director Special Markets
Manulife Wood Logan
Phone: (800) 334-4437 x7680
Fax: (203) 602-7557

 
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