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Opening a 529 college savings account can be a smart move if you’d like to save for college on a tax-advantaged basis. One thing to consider when opening a 529 plan is whether it should be a custodial or individual account. While both allow you to save for college costs and enjoy some tax breaks, they differ in terms of who has control of the account and the assets in it.
529 Plan Basics
A 529 plan, also referred to as a qualified tuition plan in the Internal Revenue Code, is a tax-advantaged education savings vehicle. There are two types of 529 plans: college savings accounts and prepaid tuition accounts.
With a 529 college savings account, you contribute money for future education costs. That money grows tax-deferred and can be withdrawn tax-free when used to pay for qualified education expenses. That includes things like tuition, fees and room and board. Prepaid tuition plans, on the other hand, allow you to set aside money for college at locked-in tuition rates.
Every state, except for Wyoming, and the District of Columbia offer at least one 529 plan. You don’t have to be a resident of a particular state to contribute to that state’s plan. Each state plan can establish its own annual and lifetime contribution limits. Money held in a 529 plan can be invested in mutual funds, index funds and other securities.
529 Plan Custodial vs. Individual Ownership
A 529 plan can be established as a custodial account or an individual account. The way the plan is set up determines who has control over the money in the account.
All 529 plans have an account owner and a beneficiary. In a custodial 529 plan arrangement, the student is both the owner and the beneficiary. But when the student is a minor, an adult custodian must manage the account on their behalf.
This custodian can be a parent, grandparent or legal guardian. The custodian’s job is to manage the funds in the 529 plan on behalf of the beneficiary until they reach adulthood. In most states, that means age 18, though in some states the age threshold may be higher.
The custodian can’t change the beneficiary or account owner. Once the account owner/beneficiary becomes an adult, they assume control over the 529 plan.
With an individual 529 plan, the owner is usually a parent or other adult who saves money on behalf of a chosen beneficiary, typically their child. The account owner makes contributions, makes investment decisions and also has the power to change the beneficiary as they see fit.
Once the beneficiary enrolls in college, the account owner can then withdraw money to pay for qualified education expenses. If there’s money left in a 529 plan after the beneficiary completes their education, the account owner can roll it over to a new beneficiary. Or they could choose to withdraw any remaining amounts. Keep in mind, however, that doing so has tax implications.
529 Plan Custodial vs. Individual Accounts: Which Is Better?
Whether it makes sense to open a custodial 529 or an individual 529 can depend on how much control you’d like to have over the account.
Opening an individual 529 could be the better option if you:
- Want to retain control over investment decision-making
- Are unsure if your beneficiary will actually go to college
- Would like to have the flexibility of changing beneficiaries or withdrawing money
As the account owner, you’d have the final say in what happens with 529 plan funds. If your child decides not to go to college, for example, you could change the beneficiary to yourself, your spouse or one of your grandchildren later on.
On the other hand, you might opt for a custodial 529 if you:
- Are comfortable handing control of the account to the beneficiary once they reach adulthood
- Do not foresee any situation in which the beneficiary might need to be changed
- Want to minimize financial aid impacts if the beneficiary plans to apply for aid
Also, you may be required to set up a custodial IRA in certain situations. If you’re planning to fund college savings using money from a custodial account that was established under UTMA or UGMA rules, for example, then you could only open a custodial 529 account.
529 Plan Custodial vs. Individual Financial Aid Impacts
Students planning to take out federal student loans must complete the Free Application for Federal Student Aid (FAFSA). The FAFSA considers the financial situation of both parents and students, including income and assets, to determine how much aid the student might qualify for.
Money held in a 529 plan, and the plan’s ownership status, comes into play when determining aid eligibility. If the account owner is the student and that student is dependent, or the account owner is the parent of a dependent student, 529 plan funds are treated as a parent’s asset on the FAFSA. Any distributions from the plan aren’t considered for aid eligibility.
If the account owner is an independent student, 529 plan funds are treated as the student’s asset. But distributions still won’t count against the student for aid eligibility. When the account owner is anyone other than a student or parent, 529 assets are not reported on the FAFSA. But any qualified distributions from the plan are treated as untaxed income for the student.
What this means, essentially, is that whether you have a 529 custodial plan or an individual 529, the impact on aid eligibility is usually limited unless someone other than a parent or student is the account owner.
How to Open a 529 Account
If you’d like to open a 529 account, custodial or individual, the first step is researching account options. Again, you can look at plans offered in each state to compare investment choices and fees in order to find the right plan for your needs.
You can open a 529 account directly with the plan or through a brokerage if you already have a brokerage account set up. The process for opening a 529 account is similar to opening any other investment account. You’ll need to provide some personal and financial information and verify your identity.
At the time you open the account, you should be able to specify whether you want to open a 529 plan with custodial or individual ownership. If you’re opening a custodial account, you’d need to provide information about the student who will be the owner and beneficiary. If you’re opening an individual account, you can name yourself as the owner and your student as the beneficiary.
Once the account is open you can start making contributions. These can be scheduled individually or you may be able to set up recurring contributions from a linked bank account. Remember that while the plan may have no annual contribution limits, you’ll need to stay within the annual gift tax exclusion limits.
For 2022, the gift tax exclusion limit is $16,000. The exclusion doubles to $32,000 for married couples. So if you have multiple kids and are married, you could contribute up to $32,000 to a 529 plan for each child. For 2023, these figures are jumping to $17,000 for individuals and $34,000 for married couples.
Bottom Line
Choosing a custodial or individual 529 plan comes down to how much control you’d like to have over the account. The most important thing to remember is that time is on your side. The sooner you begin saving in a 529, the more time your money has to grow through the power of compounding interest.
Financial Planning Tips for Education
- Consider talking to a financial advisor about whether it makes sense to open a custodial or individual 529 plan. Finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- In addition to a 529 plan, you might also consider opening a Coverdell ESA for college savings. Coverdell accounts allow you to contribute up to $2,000 per year for education savings until the beneficiary reaches the age of 18. These plans also require the beneficiary to withdraw all money in the account by age 30 to avoid a tax penalty. Your advisor can help you weigh the pros and cons of using a Coverdell Education Savings Account.
Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
