529 vs. placing appreciated securities into a UTMA account

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Topic Author
ipo_fin_z
Posts: 38
Joined: Tue Jan 30, 2018 9:28 am

529 vs. placing appreciated securities into a UTMA account

Post by ipo_fin_z »

I currently have a highly concentrated stock position (with capital gains ~ 50% of value) that I'm going to partially offload this and next year for diversification reasons. I reside in CA.

This raises questions of how to save for college for my 2 year old.

My first question: What is CA's tax rate for income in a UTMA? In the past, this would be parent's marginal tax rate, but are they now going to use the trust rules like the federal government? I'm assuming they are using the trust rules now (which is the single taxpayer bracket), but please correct me if wrong!

More analysis:

From a 2017 point of view, dumping proceeds and superfunding a 529 account seemed like a win, but with the new tax code, there's a considerable reduction in taxes on income in trusts. (federally, ltcg are 0% up to $4700/year and 15% for the next $8kish, rather than the old code of 0% for first $2k and parent's tax rate above that!).
I could dump something like $18k of securities into the account over 2 years (saving myself $4k or so of taxes), selling immediately and switching to an index fund, and then watch it grow. As long as yearly tax gain harvesting is done, that can grow to $50kish (6% rate of return) and never incur any cap gains. Needless to say, that's about 1 year at University of California.

Additionally, while I need to do the math, it seems covering the other few years with a UTMA is still better than a 529. Transferring stock from me to the kid drops tax rate on next $10k of gains from 37% to 16%, saving 10% of the overall value. 10% savings now seems like a roughly neutral trade with having to pay capital gains on the returns in 20 years (16% tax rate). -- and an obvious win when you consider the risk of overfunding the 529. (And now with around $40k injected.. 3 years of college is covered)

Final questions:
1. Am I understanding the federal tax rates correctly?
2. Am I understanding the California tax rates correctly?
3. Does this strategy work? Am I missing some major advantage of the 529 or downside of UTMA?
zrail
Posts: 100
Joined: Sun Jan 28, 2018 8:18 am

Re: 529 vs. placing appreciated securities into a UTMA account

Post by zrail »

I don't know how CA laws are going to change (I don't think many states have publicly contemplated how TCJA affects their own tax forms yet), but I will say that this is exactly how I'm handling my daughters' college savings. My plan is to dump appreciated shares into their UTMAs every year and tax gain harvest up to the top of the 0% bracket. When they're actually in college we'll probably slush some income through a 529 to get the state tax deduction but it's not going to accumulate there.
Topic Author
ipo_fin_z
Posts: 38
Joined: Tue Jan 30, 2018 9:28 am

Re: 529 vs. placing appreciated securities into a UTMA account

Post by ipo_fin_z »

Alright, here's CA's laws: https://www.ftb.ca.gov/law/legis/Federa ... s/2017.pdf
Tax on Unearned Income of Children
California conforms, under the PITL, to IRC section 1(g), relating to the tax on unearned income of
children (kiddie tax), as of the “specified date” of January 1, 2015,59 with modifications, but does
not conform to the federal simplification of the kiddie tax.
Looks like they are going to keep the rule using parent's marginal rate above $2100.
mega317
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Joined: Tue Apr 19, 2016 10:55 am

Re: 529 vs. placing appreciated securities into a UTMA account

Post by mega317 »

that can grow to $50kish (6% rate of return) and never incur any cap gains. Needless to say, that's about 1 year at University of California.
UC's in-state estimated cost of attendance is 35k on campus, almost half for room and board. If you live near a campus make them commute and you have 7 semesters covered!

Going back to the start of your post, how much of your portfolio is this stock? I would be nervous about waiting even one day to sell a concentrated position if it was very large.
ipo_fin_z wrote: Thu Aug 09, 2018 4:54 pm Looks like they are going to keep the rule using parent's marginal rate above $2100.
Thanks for finding that.
Topic Author
ipo_fin_z
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Joined: Tue Jan 30, 2018 9:28 am

Re: 529 vs. placing appreciated securities into a UTMA account

Post by ipo_fin_z »

post error - can't delete
Last edited by ipo_fin_z on Thu Aug 09, 2018 5:18 pm, edited 1 time in total.
Topic Author
ipo_fin_z
Posts: 38
Joined: Tue Jan 30, 2018 9:28 am

Re: 529 vs. placing appreciated securities into a UTMA account

Post by ipo_fin_z »

post error - can't delete
Last edited by ipo_fin_z on Thu Aug 09, 2018 5:18 pm, edited 1 time in total.
Topic Author
ipo_fin_z
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Joined: Tue Jan 30, 2018 9:28 am

Re: 529 vs. placing appreciated securities into a UTMA account

Post by ipo_fin_z »

mega317 wrote: Thu Aug 09, 2018 4:59 pm UC's in-state estimated cost of attendance is 35k on campus, almost half for room and board. If you live near a campus make them commute and you have 7 semesters covered!
I used $50k assuming 2% education inflation above inflation rates (so ~4% which is historical).
Yup, commuting saves a lot - this is why 529s are so dang annoying to plan.
mega317 wrote: Thu Aug 09, 2018 4:59 pm Going back to the start of your post, how much of your portfolio is this stock? I would be nervous about waiting even one day to sell a concentrated position if it was very large.
80%; it's terrifying. Under IPO lock-up, so trying to figure out what to do once lock-up ends. There are tax reasons to hold on to a substantial minority of the position next year.. actually explored in my first post here
mega317 wrote: Thu Aug 09, 2018 4:59 pm
ipo_fin_z wrote: Thu Aug 09, 2018 4:54 pm Looks like they are going to keep the rule using parent's marginal rate above $2100.
Thanks for finding that.
Yah, an interesting question is whether using a trust can beat out a UTMA due to CA tax savings. (I imagine the management cost might be too high though)
mega317
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Joined: Tue Apr 19, 2016 10:55 am

Re: 529 vs. placing appreciated securities into a UTMA account

Post by mega317 »

I didn't read your other thread, but if any more than about 10% of my money was in a single stock, I would give strong consideration to selling it all at the first opportunity regardless of tax cost.
boglebrain
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Re: 529 vs. placing appreciated securities into a UTMA account

Post by boglebrain »

I'm in the same boat with appreciated stock and live in CA. The stock is actually a low-cost index fund. I'm trying to decide if I should sell the equities and fund a 529 and pay the federal and state tax now and then super-fund the 529. Alternatively, I can directly gift the shares to an UTMA account for the child. I’m mostly focused on the tax optimization aspect. I’m using tax software to compute the tax amounts and I understand the standard deduction and exclusion amounts for an UTMA (treated as estates with compressed tax brackets).

Before I go into my situation, first let’s consider the extrema: If you have a lot of cash then funding a 529 plan has a lot of advantages in that the future growth is entirely tax free and there is no cost to funding the 529 plan now. There is also the added benefit of “super-funding” a 529 in year 1 instead of spreading out the gifts over a 5 year period for a UTMA. However, it seems that a UTMA account has some advantages from a tax perspective for funding and tax-gain harvesting.

At the other extreme you might have close to 100% appreciation and are sitting on a large tax bill in order to fund the 529. It may not make sense to use a 529 plan at all and just use an UTMA and slowly unwind the position.

(Note that you can also do an UTMA and then carry out any stock sales and then fund at UTMA 529 plan (instead of the traditional 529). This has been discussed on the forum.)

Here is a brief summary of the advantages of 529 and of UTMAs.

529 advantages:
* For *cash* positions, super-funding $150k gives you about $20k in additional growth over funding $30k/year into an UTMA account assuming a 6% growth rate. This is because of the additional compounding/dividends generated.
* Control over the money—give to grandkids or other children.
* Tax-free growth and withdrawal for education expenses.
* Withdrawable if child gets a scholarship.

UTMA advantages
* Ability to transfer appreciated stock into an UTMA directly.
* Flexibility to use the money for items beyond education without penalty

Let’s take an example that is not at with extrema described above. Funding a 529 with appreciated stock would be subject to LTCG tax (20% federal and ~12% CA and NIIT (3.8% Obamacare) so total tax rate is ~36%. In order fund $150k 529 plan with something that has seen 35% growth requires selling $172k and paying $22k in taxes ($14k Federal and $7.5k CA). If the stock position is something that has seen a lot of more growth, then even more tax has to be paid.

If instead you took $30k of the $172k and put it into a UTMA account in the first year you can sell 50% of the appreciated stock to tax-gain harvest (and rebalance into say 20% bonds). The second year you could continue this pattern on the capital gains and the dividends that start to accumulate and you continue for 5 years until $150k has been deposited into an UTMA account,. Note that as you do this the dividends are growing. After 5 years you will have funded $150k into the UTMA account. You can then eliminate all the initial gains you had and keep the effective federal tax rate below 6% with this strategy so after 10 years the total federal tax paid will be only $6k. For CA taxes it’s more complicated as the UTMA is subject to AMT at a rate of 7% or at the parent's marginal rate.

In summary, then for this scenario you could pay $22k in taxes and see a benefit to the super-funding the 529 plan. However, the super-funding is really a comparison to funding the 529 from cash with $30k each year. So in reality the stock (or index fund) held by the parents is continuing to appreciate each year and generate dividends. This then leads me to conclude the super-funding isn’t as good as it sounds and really only is helpful when you have the cash available.

So assuming you trust your kids the UTMA may in fact be better and more flexible than a 529 plan. If the goal is take full advantage of the gift tax exclusion every year then the UTMA could be better and then you can just pay for college outright when the time comes and the child has $150k with growth later. They will hopefully use it wisely and invest/buy a house/etc.

In order to super-fund a 529 plan with 90% appreciation you have to start with $221k and pay $71k in taxes. Instead if you take $150k of that the $221k and over 5 years gift it to an UTMA you can then over 10 years keep the total tax down to $21k thereby saving $50k. And as I noted above, in the case of 35% appreciation you spend $6k federal over a 10 year period or $12k federal in 5 years. This is compared to paying $14k now to fund the 529.

Seems like UTMA is often overlooked given the significant tax advantages it does have! Does this analysis make intuitive sense?

For California it is not entirely clear. When I initially went through TurboTax it seemed I was forced to pay AMT of 7%. But if I manually went to form 3800 and filled it out then it seems to tax the unearned income of the child at the parent's marginal rate which in my case is more.

Questions:

1) Does anyone know exactly how it works for California kiddie tax?
2) Any general thoughts on using the UTMA in this situation?
3) I see the suggestion of a trust above. Perhaps that is worth looking into for the tax savings. Are there any Vanguard-like services for trusts?

Thanks in advance.
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