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529 Plans vs. Custodial Account: What’s the difference?

529 Plans vs. Custodial Account: What’s the difference?

Parents allocate benefits for their children and in order to do so, they will use personal finance tools such as a 529 plan and a custodial account. There are differences between the two mentioned. To pay for their children’s college in the future, parents can build funds using the investment vehicle which the 529 plan provides. On the other hand, even if their child is still a minor but they want to invest and store assets for their children, then a custodial account can act as a trust for them to be able to do so. 

Types of 529 Plans

To those parents who are hoping to prepare in advance for their children’s future college expenses, there are two types of 529 plans available for them. Parents are allowed to purchase their child’s tuition either all or a portion of it years ahead of classes’ first day before the tuition rates climb up, and this is given to parents in the prepaid tuition plan. An investment plan with tax benefits is the other type of 529 plan which is called a college saving plan. In many states, state tax breaks are available, and, in particular, earnings on the plan are not subject to federal income tax. Most 529 plans are sponsored by the state and at least one of the two plan types are sponsored by every state in the country. 

Parents should be aware of which expenses qualify for withdrawal purposes since the IRS has specific rules on what you can use 529 plans.  Tuition and fees, books, supplies, and equipment are some of the qualified and accepted purposes.  

Types of Custodial Accounts

Under both the Uniform Transfers to Minors Act and the Uniform Gift to Minors Act is the term “custodial accounts” developed which also includes accounts. UTMA accounts or UGMA accounts are what custodial accounts sometimes called. An involvement of assets being deposited into an account with a custodian, who oversees the asset is what both UGMA and UTMA accounts are. Parents or a parent is typically the custodian. Upon turning the age of legality which varies between 18 and 21 they will gain access to the funds but while they are still minors, the account must be arranged for them to benefit it later on. Children owning securities and certain types of assets are not allowed in many states. A method that allows them to benefit from assets without controlling them is what the custodial account provides. 

But, is there any limitations?

The 529 plans are limited to college spending although saving for college is what both 529 plans and custodial accounts used for. The earnings on the plan become subject to federal taxes and a 10-percent tax penalty will be assessed if a parent withdraws money from a 529 plan for a purpose other than paying for college. Custodial accounts also carry restrictions but it can be used for college costs and numerous other expenses. Funds cannot be withdrawn by parents for their personal use once assets are deposited into a custodial account even if they are the custodians of the account. The child whose name the account carries must be the one who will benefit the funds. 

Flexibility of Assets

Investors of the 529 college savings plans are given choices such as bond mutual funds, stock mutual funds, and money market funds. These choices are for the securities into which their funds will be invested, although the choices typically are narrow. A wide variety of assets is what UTMA custodial accounts can contain. According to a financial aid website, FinAid.org, UTMA accounts can contain assets such as real estate, patents, and fine art which means that it doesn’t only contain different forms of securities such as stocks, bonds, and mutual funds. UGMA custodial accounts offer more flexibility than college savings plans but can only contain different types of securities. Investors will be given more choices as long the custodial accounts give greater flexibility and with that, investors will be given an option either, they want to be aggressive or conservative with their assets although those will be without the tax benefits of 529  plans. Investors better consult financial advisors to know which among them is best.

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