What’s the Difference between Custodial and Individual 529 Plans?

The differences between a custodial 529 plan account and an individual 529 plan account have to do with who controls the account while the beneficiary is a minor, and the impact of the account on need-based financial aid.

What is a Custodial 529 Plan?

All 529 college savings plans have an account owner and beneficiary. The account owner controls the account. A 529 plan is used to save for the future college costs of the beneficiary.

A custodial 529 plan account is similar to a regular 529 plan account, but with the student as both account owner and beneficiary. When the student is a minor, the account must be managed by a custodian (typically a parent or grandparent) until the student reaches the age of majority.

The custodian of a custodial 529 plan account is not the same as the account owner of the 529 plan. It is inaccurate to refer to the account owner of a regular 529 plan account as the custodian of the account.

The custodian cannot change the beneficiary or account owner of a custodial 529 plan account. The custodian must manage the custodial 529 plan account for the benefit of the beneficiary.

When the beneficiary reaches the age of majority (age 18, 19 or 21, depending on the state), the beneficiary can take over control of the 529 plan account.

What is an Individual 529 Plan?

An individual 529 plan account is the more common type of 529 plan account. An adult individual, usually a parent or grandparent, is the account owner while the student, usually the child or grandchild, is the beneficiary.

The account owner makes investment decisions involving the 529 plan.

The account owner can change the beneficiary to a member of the family of the previous beneficiary.

When the beneficiary enrolls in college, the account owner can take distributions from the 529 plan account to pay for the beneficiary’s qualified higher education expenses.

Impact of the 529 Plan on Financial Aid Eligibility

Most investments are reported as an asset of the account owner on the Free Application for Federal Student Aid (FAFSA).

529 college savings plans are an exception, in that the ownership of the 529 plan determines whether or not they are reported, and how they are reported.

• If the account owner is a dependent student or the dependent student’s parent, the 529 plan is reported as the parent’s asset on the FAFSA and distributions are ignored, i.e., not reported as untaxed income to the student.
• If the account owner is an independent student, the 529 plan is reported as the student’s asset on the FAFSA and distributions are ignored.
• If the account owner is anybody else, such as a grandparent, aunt or uncle, the 529 plan is not reported as an asset on the FAFSA. In the case of divorce or separation, only one parent – the one who provides more financial support to the student – files the FAFSA. If the non-filing parent owns a 529 plan, this will also not be reported as an asset on the FAFSA.

According to the Application and Verification Guide published by the U.S. Department of Education, “they are an asset of the owner (not the beneficiary because the owner can change the beneficiary at any time) except when the owner is a dependent student, in which case they are an asset of the parent.”

Thus, if the student is a dependent student, a custodial 529 plan is reported as a parent asset on the student’s FAFSA. This reduces eligibility for need-based financial aid by at most 5.64% of the asset value.

So, it would seem that a custodial 529 plan and a regular 529 plan owned by the student’s parent have the same impact on eligibility for need-based financial aid, with the only difference occurring when a regular 529 plan account is owned by someone other than the student or parent.

But, there is a subtle difference between the financial aid treatment of a custodial 529 plan and a regular 529 plan, and that has to do with how they are reported on a sibling’s FAFSA.

A custodial 529 plan account that is owned by the student’s sibling is not reported as an asset on the student’s FAFSA, since it is an asset of neither the student nor the student’s parent. On the other hand, a regular 529 plan account that is owned by the student’s parent is reported as an asset on the student’s FAFSA, even if the beneficiary is someone other than the student, such as the student’s sibling.

Similarly, if the parent is going back to college and files his or her own FAFSA, a parent-owned 529 plan is reported as an asset on the parent’s FAFSA even if the beneficiary is a child. A custodial 529 plan account, on the other hand, is not reported as an asset on the parent’s FAFSA.

Reasons for Custodial 529 Plan Accounts

There are several reasons why a contributor might create a custodial 529 plan account instead of contributing to a parent-owned 529 plan.

• The custodian of a custodial 529 plan account retains control over the account until the beneficiary reaches the age of majority with needing to be the account owner.
• The beneficiary of a custodial 529 plan account cannot be changed.
• A custodial 529 plan account has the same financial aid impact as a parent-owned 529 plan on the beneficiary’s eligibility for need-based financial aid.
• A custodial 529 plan account is not reported as an asset on the FAFSA of the beneficiary’s sibling, providing a way to partially shelter the assets and reduce the impact on financial aid eligibility.
• The family may be required to create a custodial 529 plan account if the funds came from a custodial bank or brokerage account.
• The contributor can use a custodial 529 plan account to keep the account’s existence a secret until the beneficiary reaches the age of majority.

Comparison Chart of Differences

This table shows the differences among the two types of 529 plan accounts.

Converting a Custodial Account to a 529 Plan

UGMA/UTMA accounts are custodial accounts established for a child under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). If the parents have opened an UGMA/UTMA account for their child, they may consider converting it to either an individual or a custodial 529 plan account.

UGMA/UTMA accounts offer greater spending flexibility than 529 plans, but they don’t offer many of the benefits of 529 plans. For example, UGMA/UTMA accounts are considered a student asset on the FAFSA. Student assets are counted at 20% of the value, as opposed to only 5.64% for the 529 plan which is consider a parent asset. This can reduce financial aid eligibility.

There are several pros and cons to consider before deciding whether it makes sense to convert your custodial account to a 529 plan account.