Ask the Experts: How does an UGMA/UTMA custodial account compare to a 529 plan when saving for college?
Both an UGMA/UTMA custodial account and a 529 plan can be used to save for college. But after comparing a few key features, the 529 plan probably comes out ahead.
Taxes–Income in a 529 plan grows tax deferred, and withdrawals used to pay college expenses are completely tax free at the federal level (and possibly at the state level too). But any income earned by assets in a custodial account (for a child under age 18) is taxed under the “kiddie tax” rules–the first $850 is tax exempt, the next $850 is taxed at the child’s rate (usually 10%), and anything over $1,700 is taxed at the parent’s rate.
Investment flexibility–With a custodial account, you have complete control over the investments you decide to place in the account (assuming you’re the custodian). But with a 529 plan, you’re limited to the investment offerings preselected by the plan.
Control–Assets contributed to a custodial account are considered irrevocable gifts to your child. Second, withdrawals can only be made for your child’s benefit, not yours. And once your child reaches age 21 or 25 (for UTMA accounts) or age 18 (for UGMA accounts), the custodianship ends and your child receives sole control of all assets in the account. This is a drawback for some parents who believe their child may not use the money for college. By contrast, as account owner of a 529 plan, you can change the beneficiary at any time, you control the funds all the time, and you can withdraw money for purposes besides college (though you will pay a 10% federal penalty on the earnings portion).
Financial aid–Under the federal aid formula, 529 plans are considered a parent’s asset (if the parent is the account owner) while custodial accounts are considered a child’s asset, a less favorable classification. This is because children must use 35% of their assets for college expenses (20% starting July 1, 2007), but parents must use only 5.6% of theirs.