Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
Saving for Education: Are You Optimizing Your Child’s Custodial Account?
Published Date : November 18, 2013
As the buzz of activity surrounding schools and universities increases, we’re reminded of the planning required to effectively save for our children’s higher education. The options currently available to families interested in setting aside investments for higher education are primarily limited to custodial accounts and 529 plans. Over the last decade, 529 plans have evolved to provide tax, ownership and funding advantages not available to traditional custodial accounts. Recently, a hybrid 529 plan has been developed by many plan administrators to capture the tax advantages of a 529 plan while retaining the ownership structure of a custodial account. While a 529 plan remains the current optimal choice for saving for college in a tax exempt manner, the custodial 529 account is a relatively new option for parents who would like to optimize the tax treatment of an existing custodial account.
The traditional custodial account is a non-tax advantaged investment account that is officially owned by the minor, but under “custody” of the adult prior to the beneficiary reaching the age of majority. Upon reaching the age of majority, the beneficiary has complete control and authority over the assets and is not limited in any way on how the funds are to be directed. The 529 plan is an educational savings account that receives preferred federal tax treatment on qualified distributions used to pay for educational expenses such as tuition, fees, books, and related supplies. These plans are funded with after-tax contributions made into accounts that are invested in mutual funds whose growth is deferred from Federal and sometimes state taxes. Qualified withdrawals from the plan are eligible to be used toward any college, university, vocational school, or other postsecondary educational institution. While each state offers its own individual 529 plan, an account owner is free to participate in any state plan offered regardless of residence. A 529 plan is owned by an adult, who retains ownership for the life of the account and has the ability to choose and change the beneficiary over time.
An option worth reviewing is the transition of an existing custodial account to a custodial 529 account. The custodial 529 has all of the tax exempt attributes of a 529 plan with an ownership restriction that does not allow the parent to change the beneficiary while the child is a minor. Since the original custodial account is owned by the child, the parent or custodian does not have the right to give the child’s property to another beneficiary. There are two aspects of the original custodial account that may not warrant a transition to a custodial 529 plan. If an owner of a custodial account plans on using the funds for expenses other than education, then the tax advantage is lost and a 10% penalty will be placed on the earnings for a non qualified distribution. Also, if a custodial account is very small and annual income (interest, dividends and net capital gains) is less than $950 in 2014, then the tax exemption will be of no value since a child pays no tax on unearned income below $950. Finally, the funding of a custodial 529 plan must be in cash, so one should take into account the tax consequences of liquidating the original custodial account.
To determine if your specific custodial account is a good candidate for a transfer to a custodial 529 account, please contact your wealth manager to learn more.
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