529 College Savings Plans

Custodial Accounts

Custodial accounts - Uniform Gift to Minors Act (UGMA) accounts or Uniform Transfer to Minors Act (UTMA) accounts - are another tax-advantaged way to save for college. A parent, grandparent, or other adult is custodian for the account and makes all the investment decisions until the child for whom the account was opened reaches the age of majority. UGMA accounts are limited to money and securities. UTMA accounts can hold other types of property. You can set up these accounts at almost any brokerage firm, mutual-fund company, or other financial institution.

Advantages
For children younger than 14, the first $750 in earnings in a custodial account is tax-free. The next $750 in earnings is taxed at the child's federal tax rate. Any earnings over $1500 are taxed at the custodian's federal tax rate. For children over 14, the first $750 in earnings is still tax-free, and all earnings after that are taxed at the child's tax rate. To learn more about the tax rules for children, you should read IRS Publication 929: Tax Rules for Children and Dependents.
As with ESAs, your investing options are virtually limitless. Nor are there any contribution or income limitations. In addition, withdrawals can be used for any purpose, not just qualified education expenses, without penalty.
Disadvantages
When your child reaches the age of majority - 18 to 25 depending on the state you live in - he or she takes over control of the account and can use the money in the account for anything. Because you lose control over how the money may be spent, some parents and grandparents may not like this option. Another potential disadvantage is that because the account is considered the child's asset, you can't switch beneficiaries. So if your child decides not go to college or gets a scholarship, you can't switch the money to a brother, sister, or other family member.

Tax-Free Transfer to a 529 Plan. You now can transfer funds from a custodial account to a 529 plan if the plan accepts such transfer. However, you must liquidate any investments you have made in a custodial account because you can only transfer cash and pay taxes, if any, on any gains. Another problem with transferring custodial account funds is that the money is the child's asset, not yours, so you cannot transfer the 529 plan to another beneficiary. There also may be other restrictions and limitations.

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