Saving For Your Child’s College Education: An Overview of Custodial Accounts & The 529b


As a mom to twins, one of my financial goals is to be able to support my kids when they go to college and as a result, I have a couple things in place to support this plan. I have split college savings for each of my children between custodial brokerage accounts and 529b plans and this article provide an overview of both account types.

What is a custodial brokerage account?

A custodial brokerage account is fairly easy to figure out in the sense that (in my instance) it is simply an account that an adult controls for minors under the age of 18 (in some states 21). In my custodial accounts, I can invest funds in the stock market towards designated financial goals I have set for my children with saving for college being one of them.

There are a few very important factors to keep in mind with custodial accounts and they include the following:

Important factors to consider with a custodial account

  1. When you transfer money into custodial accounts the money is no longer yours, it now belongs to your child and you are essentially the custodial manager. This means legally, you are only allowed to use the funds in this account for expenditures that benefit your child, not yourself.
  2. Once your child reaches age 18 or age 21 (depending on the state) they are no longer a minor and will gain full control of the account, so it's important to begin teaching your children financial responsibility as early as possible.
  3. Your child might need to pay taxes on any income the account makes and file a seperate federal tax return if that income exceeds $1,000, unless it's income from interest, dividends or capital gains - this you can include in your own tax returns (It's best to clarify this with a qualified tax accountant).
  4. You might be required to pay gift taxes if you put more than $14,000 a year into a custodial account for each child.

The next type of account I have for my children is 529b savings and this is slightly more complicated.

What is a 529b account?

A 529b is a college savings plan that is sponsored by a state or state agency in which you can set aside funds for your child to be used towards their future college expenses i.e. tuition, books and other educational expenses. These funds can only be used at accredited 2 or 4-year colleges, vocational and technical schools, or at eligible foreign colleges. Contribution limits are typically between $300,000 and $500,000 depending on the state.

529b's are typically set up by state but you have the option to open a 529b in a state different from where you live. Some states offer special tax deductions if you open a 529b in the state where you live but you want to make sure you are aware of all restrictions on the account including where your child can attend college as well as the fees and expenses you will be paying in comparison to the tax deduction you will get.

For example, I chose the New Hampshire 529b plan although I live in New Jersey because under this plan my kids can go to college anywhere in the country and at the time of writing this my state does not offer any sort of tax deduction or incentive around the 529b.

Benefits of the 529b

The main benefit of having a 529b in place for your child is the tax benefit. Once you begin making contributions, your earnings can grow tax deferred and if the money is used for qualified education expenses (as mentioned above and which is the purpose of the 529b)  then those distributions will not be taxed by the federal government.

Taking money out of a 529b

You may take money out of a 529b at any time for any reason but if the money is not being used towards your child's college education expenses, then it is subject to income tax as well as a 10% federal tax penalty.

How your money is invested in a 529b

Since the 529b is a state-sponsored program, your money will typically be invested on your behalf by established brokerage firms (where you can open your 529b account) in a variety of funds and you can pick what plan works best with your objectives for your child's college savings.

One of the most popular approaches is to select that your funds are invested based the age of your child. This approach starts out investing more aggressively but as your child approaches college age, the investment mix will get more conservative moving more money into cash and bonds vs. funds. Alternatively, you can create your own investment mix from available portfolios offered by the brokerage firm in their 529b plans.

To take a deeper look into 529b, visit the IRS website here.