The question is: if I want to help a grandchild or child save for college, should I be using a 529 savings plan or a custodial account? In addition to other ways of saving for future college expenses, these are two of the most popular options.

Custodial Accounts

Custodial accounts have been around for much longer and they’re a good way to put money away for a child or grandchild for their benefit down the road. An advantage of custodial accounts is that the funds can essentially be used for anything as long as it’s for the benefit of the child or minor. It doesn’t necessarily have to be school or higher education types of expenses. You can really use the money for anything.

The Downsides to Custodial Accounts

What are the downsides people often talk about with custodial accounts? When the child becomes the age of majority, which could depend on the state that they live in, whether it’s 18 or 21, it automatically becomes their money. If they want to take all the money out and spend it on what they want to spend it on, that’s essentially perfectly legal. They can do that. Another disadvantage of custodial accounts is in the federal needs based financial aid methodology. They will factor a little bit more heavily into that methodology versus a 529 savings plan.

529 Savings Plans

About 20 years or so ago came about the 529 college savings plans. If you definitely want to save for qualified higher education expenses, these are a really good way to do that. You do not get a federal tax deduction for putting money into a 529 college savings plan, but if you use your state’s plan, you might be able to get a state tax deduction.

Connecticut for example, where we’re primarily located, has a state tax deduction for contributions to a 529 plan. Up to $5,000 for a single individual or up to $10,000 for a married couple filing jointly. The state tax deduction is an advantage that you could possibly get for putting money into a plan. You also get tax deferred growth. If the money is growing and kicking off interest, dividends, capital gains and things like that, you’re not getting taxed on it. As long as you use the money at some point for qualified higher education expenses, the earnings on it is tax free. There are some ways to use the money for private school leading up to college, but there are some limitations.

Custodial Accounts vs 529 Savings Plans

In contrast to custodial accounts, 529 college savings plans don’t escape the federal financial aid methodology at all, but it will factor in a little bit less. A downside to a 529 college savings plan is if you take out the money and you’re not using it for qualified higher education expenses, there are some tax penalties in that year.

Thanks for joining me and I hope you found this information helpful!