Guard account versus 529 plan: which is better?
Parents have the option of building funds for their child’s education through savings instruments such as a 529 plan or custody account. Both of these options allow adults to store money that could one day support their child’s future. But which one is right for you? It all depends on what you expect from your savings tool, including tax benefits, contribution limits, and flexible beneficiary transfer. With that in mind, here is the information you need to know when choosing between a custody account and a 529 plan.
A financial advisor can offer great advice on how to make sure your family has the money they need to cover education expenses.
Custody account in relation to plan 529: accounts
From custody accounts, parents or guardians can open them on behalf of a minor. They are basically taxable trusts in which you store assets until the child reaches a certain age. Once they have reached “the age of majority”, usually between 18 and 21, they can access the account. This includes all returns made on the investment and the original principal.
Custodial accounts come in two forms: Uniform Gift to Minors Act (UGMA) accounts and Uniform Transfers to Minors Act (UTMA) accounts. UTMA accounts hold almost all types of property including real estate while UGMA accounts are limited to financial products. This includes assets such as cash, annuities, and securities.
Then you have the alternative savings vehicle known as the 529 plan. With the District of Columbia, every state sponsors at least one 529 plan, or a “qualified education plan.” And, like custody accounts, there are two types: prepaid tuition plans and general savings plans.
A savings plan is the simpler version. Parents can put money into it and possibly use the funds for eligible college expenses, i.e. tuition, room and board, and mandatory fees. In comparison, the prepaid tuition option allows the adult to purchase units or credits from participating institutions for future tuition fees at today’s prices. However, these plans generally do not cover room and board.
Custody account in relation to plan 529: taxes
If you’re looking for tax benefits, you’ll probably want to consider a 529 plan. Using funds from an education deposit account doesn’t come with tax benefits. However, the IRS considers the minor to be the owner. This comes with an advantage. Children under 19 (or 24 for full-time students) who file a return keep the first $ 1,100 of annual unearned income tax-free. After that, the next $ 1,100 is taxed at the minor’s tax rate. Any unearned income above the $ 2,200 limit is taxed at the parent rate.
On the other hand, 529 plans benefit from tax advantages on their withdrawals. Similar to a Roth IRA, the account’s investments increase tax costs. Plus, you can withdraw funds tax-free as long as you use the money for qualifying expenses. Thus, undergraduates and graduates can offset all qualified education costs. However, expenses at the K-12 level have a tax-free annual withdrawal limit of $ 10,000. After that, they (and non-qualifying expenses) are subject to income tax and a 10% penalty.
Deposit account vs. Plan 529: Contributions
Technically, parents won’t face an annual limit when contributing to a 529 plan or a minor’s custody account. However, they face gift tax limits. According to the IRS, the 2021 limit is $ 15,000 per parent and $ 30,000 per married couple.
It is also possible for parents to pre-load their child’s 529 plan and thereby bypass the gift tax limit. Essentially, the IRS allows you to contribute up to five years of annual tax exclusion without consequence. So instead of paying $ 15,000 for your child per year, you invest $ 75,000 immediately. Contributing with your spouse allows you to put in a total of $ 150,000.
These larger contributions avoid donation taxes and allow you to benefit from compound interest. But adults should pay attention to the state limits set on their plan, in advance.
In comparison, custody accounts are not subject to any contribution limits other than the lifetime tax exclusion of donations ($ 11.7 million per person or $ 23.4 million per couple).
Custody account in relation to plan 529: ownership
The funds in a 529 plan never transfer ownership from a parent to a beneficiary. This is actually a benefit for the account holder. This gives them additional flexibility if the child chooses a different path or only uses part of the money. For example, the firstborn in a couple can go to college. However, the child does not use all the funds in account 529. In this case, the parents can use the rest of the money for the education of a younger brother. You can change beneficiaries without negative tax consequences as long as the next beneficiary is still family.
On the other hand, you do not have the same flexibility with a UGMA or UTMA account. They are considered irrevocable gifts when the adult invests on behalf of the minor. Thus, they simply supervise the child who will take possession of it once he reaches adulthood. Therefore, you cannot change the beneficiary. Since these funds are part of the minor’s estate, they can also have a greater impact on financial aid eligibility than a 529 plan.
But, once the UGMA or UTMA account is in the child’s hands, they have more control over their spending than with a 529 plan. Therefore, custody accounts represent more flexibility for the child since they are more flexible. ‘they can use the funds for their own benefit in other ways.
Custody account versus 529 plan: which one is right for you?
In the end, custody accounts and 529 plans each have their pros and cons. It is up to each family to decide on the right option for them. Factors such as current financial situation, goals for the child and more can all affect how parents make their decision. It also depends on the compromises they are willing to accept. For example, guardians may want to take advantage of the tax benefits of the 529 Plan.
However, 529 plans come with more usage limitations. You can’t reallocate the funds there for something else. You can only transfer them to another parent if your child is not going to college. Otherwise, you risk heavy financial penalties.
On the other hand, custody accounts lack tax advantages but allow more flexibility. The child is not limited in its use. They can invest the money in things outside of school that are still important.
Child care accounts and 529 plans are great tools for families to save for college. A custody option like a UTMA or UGMA account offers more flexibility when it comes to spending funds. However, some of the tax benefits are missing. In contrast, 529 plans allow you to take advantage of tax-free withdrawals, but incur stiff penalties if you don’t use the money for an eligible expense or beneficiary.
Tips for saving
Consider working with a financial advisor as you find the best way to prepare for college. SmartAsset’s free tool connects you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is best for you. If you’re ready to find an advisor who can help you reach your financial goals, start now.
Savings accounts are a great tool for education spending. But if you want to get the most out of your investment and build wealth, you need one with a higher return. You can compare your interest rate on a high yield savings account with college savings vehicles like a 529 plan or deposit account to find the right option for you. The higher the interest, the more money you can earn in the long run.
Don’t stop shopping around for the right savings option until you’ve found the right one. Other choices, like CDs and money markets, can help you reach your financial goals. Whichever avenue you choose, be sure to check with a savings calculator. This way you can track your progress and plan for your future.
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The after-custody account vs 529 plan: which is better? first appeared on the SmartAsset blog.