Custodian can invest in 529 plan



Dear Joe, I need information on possibly converting my custodial account to a 529 plan. -- Larry


Dear Larry,

Technically speaking, you cannot convert a custodial account to a 529 plan. However, you can decide to invest custodial assets in a 529 plan. If a custodian decides to open a 529 account, the custodianship, which was established under your state's Uniform Gifts to Minors Act, UGMA, or Uniform Transfers to Minors Act, UTMA, stays in place. Furthermore, the rights of the minor beneficiary do not change, which means the child takes direct control of the 529 account when the custodianship terminates at age 18 or 21.

Let's assume the UGMA or UTMA account is currently invested in mutual funds. The dividends and capital gains distributions generated by the mutual funds are taxable to the child. The kiddie tax will cause unearned income in excess of $1,700 to be taxed at the parents' tax bracket. This year the kiddie tax applies to children age 17 and younger. Starting in 2008, the kiddie tax is expanded to include most 18-year-olds along with full-time college students ages 19 to 23, unless they have earnings of more than one-half of their support.

By moving the assets out of mutual funds and into a 529 plan, you would be eliminating the tax on future investment earnings, assuming the 529 money is eventually distributed tax-free for college. For anyone subject to the kiddie tax, this can save substantial income taxes. However, the 529 plan will only accept cash contributions, so you would have to first liquidate the current investments. Upon their sale, any capital gains will be taxed to the child, possibly at the parents' rate because of the kiddie tax.

Some parents may be thinking about moving custodial assets into a 529 plan, not because of the potential tax savings, but because they want to prevent the child from controlling any unspent funds at 18 or 21 years old. Unfortunately for the parents, the laws protect the rights of the child. When the 529 account is established, the custodianship should be disclosed to the 529 plan administrator. A 529 plan tagged as a "custodial 529" will not permit a beneficiary change until after the minor takes direct control of the account after reaching the age of majority.

Custodial assets and income are generally treated as the student's assets and income when applying for financial aid, and they are assessed heavily in the aid eligibility formula. A special exception removes a dependent student's self-owned 529 plans and Coverdell education savings accounts, or ESA, from the free application for federal student aid, or FAFSA, for this school year (2007 to 2008) and next (2008 to 2009). Beginning with the 2009 to 2010 school year, student-owned 529 plans and ESAs will be treated as parent-owned 529 plans and ESAs -- still a good deal considering parental assets are counted at a much lower rate than student assets.

Popular Questions


Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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