A 529 plan and a custodial account are personal finance tools that parents use to benefit their children. A 529 plan provides an investment vehicle designed for building funds to pay for college for children, while a custodial account acts as a trust that enables parents to store and invest assets for their children while the children remain minors.
529 Plan Types
Two types of 529 plans are available to parents hoping to prepare for future college expenses. The prepaid tuition plan allows parents to purchase a portion or all of their child's tuition years ahead of the first day of classes, locking in tuition rates before they climb. The other type of 529 plan, a college savings plan, is an investment plan with tax benefits. In particular, earnings on the plan are not subject to federal income tax, and, in many states, state tax breaks are available. States sponsor most 529 plans, and every state in the country sponsors at least one of the two plan types.
Custodial Account Types
The term "custodial accounts" includes accounts developed under both the Uniform Gift to Minors Act and the Uniform Transfer to Minors Act. Consequently, custodial accounts are sometimes called UGMA accounts or UTMA accounts. Both UGMA and UTMA accounts involve assets being deposited into an account with a custodian, who oversees the assets. The custodian typically is a parent or parents. The account must be arranged to benefit a minor, who will gain access to the funds upon turning the state's legal adult age, which varies between 18 and 21. In many states, children are not allowed to own securities and certain other types of assets. The custodial account provides a method for allowing them to benefit from assets without controlling them.
Both 529 plans and custodial accounts are used for saving for college, but only 529 plans are limited to college spending. If a parent withdraws money from a 529 plan for a purpose other than paying for college, then the earnings on the plan become subject to federal taxes, and a 10-percent tax penalty is assessed. Custodial accounts can be used for college costs and numerous other expenses, but they also carry restrictions. Once assets are deposited into a custodial account, then parents, even if they serve as custodians of the account, cannot withdraw the funds for their own use. The funds must be used to benefit the child whose name the account carries.
Although 529 college savings plans give investors choices for the securities into which their funds will be invested, the choices typically are narrow, centering on bond mutual funds, stock mutual funds, and money market funds. UTMA custodial accounts can contain a wide variety of assets. This means that UTMA accounts can contain not only different forms of securities, such as stocks, bonds, and mutual funds, but also assets such as real estate, patents, and fine art, according to FinAid.org, a financial aid website. UGMA custodial accounts can contain only different types of securities, but still offer more flexibility than college savings plans. The greater flexibility of custodial accounts provides investors with more choices about how aggressive or conservative they want to be with their assets, though without the 529 plans' tax benefits.