Custodial Account vs. 529 Plan: Which Is Right for You?

Like most parents and guardians, you’d probably be delighted to get your kids off to a healthy financial start in life. But where do you begin? And what if you’d love to put your kids on a healthy financial path but don’t necessarily have much money to invest?

One great place to consider starting is a custodial account. It’s a type of investment or savings account for the kids in your life, and it includes a number of investing and tax benefits. Plus, with certain custodial accounts, you can invest in fractional shares, which means you don’t have to have a lot of money to get started. For example, you can start investing with $1 when opening a Stash custodial account. It might not feel like much, but setting just a few dollars aside now, a little at a time, can make a big difference later.

Thinking about a custodial account vs. a 529 plan

There are a number of key differences when it comes to a custodial account vs. a 529 plan, but here’s the big picture: With a custodial account, the money is essentially a gift to the child, and once they reach adulthood, it’s theirs to use however they want. They can, for example, use the money to fund their education, start a business, purchase a first home, or buy a car. By contrast, a 529 must be used exclusively to fund higher education, including tuition, room and board, books and supplies, and computers.

What is a custodial account?

A custodial account is an investment account that you hold and make contributions to on behalf of a child under the age of 18 (or in some states, 21). This type of account is also referred to as a Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). UTMAs allow for investments in a broader range of assets, including real estate, while UGMAs confine themselves to more traditional securities.

Who can open a custodial account?

You don’t have to be a parent or guardian to open a custodial account for a child—you can also be a family member or friend. You (the custodian) will manage the money and investments in the account until the child reaches the “age of majority,” which varies by state but is normally 18 or 21. Usually only the custodian makes contributions to the custodial account.

Where can you open a custodial account?

Most banks and online brokers offer custodial accounts as part of their package of investment offerings.

How much can you contribute to a custodial account?

There’s no limit to how much a custodian can put into this type of account each year—and no maximum lifetime limit.

There are, however, tax implications to consider. As of 2022, the custodian can put up to $16,000 into the account without triggering what’s called the gift tax—and for married couples, this amount is $32,000. But annual contributions are not tax-deferred, unlike some retirement accounts, including traditional IRAs. Important note: this should not be construed as tax advice—please consult a tax professional to discuss the best approach for your personal tax situation.

What happens after you open the account?

Once the account is initially funded, you can invest the funds just like you would in any other investment account. That means the cash you put in can be invested in stocks, bonds, mutual funds, ETFs, and sometimes more. So a custodial account can be a great teaching tool to show the kids in your life how to invest—and to show them how money can grow over time.

If you’d like your kids to get some hands-on practice of their own with investing, ask their teachers if they’re using Stash101 at school. Stash101 is a free simulated banking and investing platform that helps kids learn all about money, including investing.

Here’s something really important to keep in mind with custodial accounts: Any securities or funds transferred in immediately and irrevocably become the property of the minor. However, the custodian has the sole responsibility of managing the assets until the beneficiary becomes an adult.

How do withdrawals work?

The custodian can take cash out of the account at any time, as long as the funds are used to benefit the minor. However, there may be charges, including liquidation or back end fees for mutual funds or other securities. The capital gains might also need to be reported on the child’s tax return or the custodian’s.

Once the minor is designated as an adult (at age 18 or 21, depending on their state), they can use the money for anything.

What about taxes?

In 2022, the first $1,150 of unearned income qualifies for the standard deduction, with the next $1,150 taxed at the child’s tax rate—and anything above $2,300 taxed at the parent’s normal tax rate. But as mentioned above, this should not be construed as tax advice. Please check with your tax advisor for specific details and to see how the tax situation would apply to you.

What else is there to consider?

Because a custodial account counts as an asset for the beneficiary, it can affect the ability of your child to get financial aid, potentially reducing the amount of assistance they receive. Please check with your tax advisor for more information.

By comparison, what is a 529 plan?

• A 529 must be used exclusively to fund a child’s higher education, or for related educational expenses.
• The minor is not the owner. Instead, the custodian of the account maintains control for as long as the account exists.
• There are lifetime contribution limits to a 529, which vary by state and are generally between $235,000 and $529,000.
• Money in a 529 is typically invested in a portfolio of stocks, bonds, and funds.
• Unlike a custodial account, earnings in a 529 grow on a tax-deferred basis.
• 529s are offered by individual states, but you are not limited to your state of residence to select a plan.
• Most states offer a tax deduction for funding the accounts, and you don’t pay federal or state taxes for distributions that go toward qualified educational expenses.
• Like a custodial account, a 529 is considered an asset that can reduce financial aid.

Investment advisory services offered by Stash Investments LLC, an SEC registered investment adviser. Investing involves risk and investments may lose value.

“Kids Portfolio” is a custodial UGMA / UTMA account. Money in a custodial account is the property of the minor. This type of account is a Non-Discretionary Managed account.