Strategic Savings for Your Child's Future
Here at Wealth|KC, we are often asked about the best way to save for a child's future education. Two popular options are 529 plans and custodial accounts. Both have their own advantages and disadvantages, so it's important to understand the difference before making a decision.
529 Plans
529 plans are state-sponsored college savings plans that offer tax advantages. Contributions to a 529 plan grow tax-free, and withdrawals used for qualified education expenses are also tax-free. Qualified education expenses include tuition, fees, books, and room and board.
In some states, they even offer state tax benefits. Most states offer a tax deduction for contributions to a 529 plan, and some states also offer a tax credit. The amount of the tax deduction or credit varies from state to state.
Another benefit of 529 plans is that they can be used to pay for a variety of qualified education expenses, including college, trade school, and even K-12 tuition.
However, there are also some drawbacks to 529 plans. One is that withdrawals for non-qualified education expenses are subject to income tax and a 10% penalty. Additionally, there are contribution limits for 529 plans. The annual contribution limit for 2023 is $16,000 per beneficiary.
Custodial Accounts
Custodial accounts are another popular option for saving for a child's education. Custodial accounts are investment accounts that are owned by the child, but managed by a custodian, typically a parent or grandparent, until the child reaches a certain age, typically 18 or 21.
The biggest benefit of custodial accounts is their flexibility. Custodial accounts can be used for any purpose, including education, housing, or even to start a business. There are no contribution limits for custodial accounts, and withdrawals are not subject to the 10% penalty that applies to non-qualified withdrawals from 529 plans.
However, there are also some drawbacks to custodial accounts. One is that contributions are not tax-deductible, and earnings are taxed at the child's tax rate. Additionally, the child becomes the owner of the custodial account when they reach the age of majority, so they can choose to use the money for any purpose they want.
Utilizing Both 529 Plans and Custodial Accounts
We typically recommend utilizing both 529 plans and custodial accounts to save for their child's future. This can be a good strategy if you want to take advantage of the tax benefits of 529 plans while also maintaining some flexibility. The scenario we want to avoid would be saving a lot of money into your child’s 529 plan and then they choose not to attend college, making it very difficult to remove money from the 529 plan without paying penalties.
The exact amounts you should save into both accounts are dependent on your unique situation. Working with a financial professional can help you make the best decision for your situation. Either way, no matter which option you choose - the earlier you start saving, the more time your money has to grow.
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Will