Written by: Derek Majkowski. Any opinions are those of Derek Majkowski and not necessarily those of RJFS or Raymond James.
Often I’m asked to explain the differences between using a 529 account vs. that of a Custodial account, and if I have any preference over which one I like better. Most of the time I am asked the question in conjunction with which approach is better for college saving.
To answer the question, it’s important to understand some of the differences, and how each intends on assisting a respective beneficiary. I have attached a link below to the Raymond James website that will speak in greater detail each of the options available, but I highlight some key points I would like to touch on regarding the two more popular strategies.
First – 529 Plans are accounts that are owned by an individual (typically a parent or grandparent) for the benefit of a respective beneficiary (a future college student). The funds are set aside specifically to fund a college education. This is typically expenses directly related to schooling (tuition, books, room and board). It is advantageous to the owner whereby allowing funds to grow tax-deferred, and then come out tax-free when meeting these very specific higher education expenses. Also, this account is still under the owner’s control, and can provide some flexibility.
A Custodial account is basically a fiduciary account being run and managed on behalf of the beneficiary. In this simple example, a parent or grandparent is simply the custodian for a child until they reach the age of majority (typically 18 or 21 – depending on the state the account resides). This means at 18 or 21, the money belongs to the minor-now-adult. No strings attached, and not necessarily to be used for college. There are also some tax benefits to placing the money in custodial accounts, but ultimately any money gifted is treated as an irrevocable gift.
Now back to the question. Which do I prefer when saving for education? My answer, is both!
The 529 Plan is the best account for a parent or grandparent to address the ever-growing expenses connected with going to college, and it provides several tax advantages. Potential present day state tax deductions, tax-deferred growth, and tax-free distributions toward direct education expenses is very appealing, and the 529 account should serve as the primary funding vehicle for direct college expenses.
That said, a Custodial account also represents a great way to provide education for a child as well. It is a way to get a child involved with understanding the importance of saving, investing, and growth of money over time. It assists kids with connecting to both the mechanisms of accounts, but also the utilization and reward associated with money. Once they do reach their college years, often coinciding with reaching the age of majority, what a great time for a young adult to have some access to money. It provides some funds for expenses during the college years that a 529 plan (or Mom and Dad) won’t cover.
When comparing the two accounts, I suggest the 529 for the majority of college funding, and custodial accounts as a great account to place birthday, holiday, and part of the weekly allowance money. Both will serve your child’s or grandchild’s education greatly.
Link: http://www.raymondjames.com/college_planning.htm
As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state.