College Q&A: A 529 or Trust Account?

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Welcome to MainStreet's newest series. Each week, we will answer a real question from readers on education costs and how to pay for college. If you have a question, feel free to send it to editors@mainstreet.com.

Q: "We have a nest egg for our kids' college funds. We are pretty risk-averse, and hope to grow this seed money with good returns but as little risk as possible.  The money is currently in a uniform trust for minors account, which is conservatively invested.  Are we better off using a 529 plan, or would we wind up subjecting the funds to too much market uncertainty that way?"

- Bill, Bethesda, Md.

A: Generally, high-return investments have higher risk of loss, and low-risk investments offer a lower return. If there were a high-return, low-risk investment, everybody would be pursuing it.

Saving for college involves balancing the risk against the return. In any 17-year period, the stock market drops significantly at least two or three times. You can’t avoid the risk, but you can manage it through an age-based asset allocation.

When your children are young, you can afford to invest in stocks and other high-risk funds. The potential dollar losses are smaller since your savings are smaller and you have a decade or more to recover from the losses. When college approaches, however, the potential dollar losses are much higher and there isn’t much time to recover from a loss. The money should be invested conservatively, and all 529 college savings plans offer age-based asset allocation schemes.

If you don’t feel comfortable investing in stocks, you should stick to low-risk investments like certificates of deposit. Some of the state 529 college savings plans now offer CDs. However, you should realize that the interest rate on a CD is unlikely to provide a good hedge against tuition inflation.

Whatever you do, don’t keep the money in a uniform trust for minors account if you think you might qualify for need-based student financial aid. A UTMA account is treated as a child asset on need analysis forms like the Free Application for Federal Student Aid (FAFSA). This may affect your children’s eligibility for need-based student financial aid because child assets are assessed more severely than parental assets.

Going further, child assets are assessed at a rate of 20%. Some parent assets are sheltered, and the remaining assets are assessed on a bracketed scale with a top bracket of 5.64%. Thus every $10,000 in the child’s name will reduce need-based aid eligibility by at least $1,436. If you liquidate the UTMA and use the proceeds to invest in a custodial 529 college savings plan, it will be treated as though it were a parent asset on the FAFSA.

—Mark Kantrowitz is president of MK Consulting Inc. and publisher of the FinAid.org and FastWeb.com. He has testified before Congress about student aid on several occasions and is on the editorial board of the Council on Law in Higher Education.

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