Switching to a 529 plan, however, might not erase all the disadvantages of an UGMA. Any amount transferred from an UGMA to a 529 still reverts back to the child if it’s not used for qualified education expenses, warns Louis Chiavacci, a senior vice president in Merrill Lynch’s private client group. There’s also a 10 percent penalty to pay if the funds aren’t used for the specified purpose of funding a college education.
Another problem in switching from an UGMA is that you can’t make new contributions to the 529 once it’s established. The contributor would have to set up a separate 529 account for the new funds. In some cases, however, the split can supply needed diversification. Says Chiavacci: “One [plan] may be invested more conservatively than another.”
CFOs Need Not Apply
Another vehicle that enables parents to hold onto the investment reins is an education IRA, also known as a Coverdell Education Savings Account. One particular advantage is of the Coverdells, which, like 529s, are exempt from federal taxes, is that you can use them to pay for any form of education from kindergarten on up.
But education IRAs permit only tiny contributions relative to what college costs these days. Even with a boost of $1500 this year, the annual limit is still only $2,000. In fact, many highly paid CFO earn too much to be able to make use of Coverdells: The ability to make contributions phases out for married couples with adjusted gross incomes between $190,000 and $220,000.
Nevertheless, parents may want to consider Coverdells, UGMAs and other college funding options because some 529 benefits may be gone by the time today’s codgers head off for academe. The 2001 tax act governing 529s sunsets in 2010, meaning that, beginning in 2011, the rules will revert back to what they before the 2001. That, in turn, means that the money in 529 funds would still accrue on a tax-deferred basis. But it would become taxable at the child’s rate when it’s withdrawn.
Says Weiner: “That’s still an advantage. Even if the child has to pay income tax when they use the money, it’s still better than paying in a parent’s tax bracket. That’s why a lot of people are still in favor of using these accounts.”
There are indeed more risky ways to fund the high cost of higher education. Consider “Stealing Harvard,” a soon-to-be released comedy about a man who turns to a life of crime to pay for his niece’s tuition at the famed Ivy. Thanks to 529 plans and their ilk, thoughts of such a solution can be left at the movies.