What’s the Difference in a 529 Plan and a Custodial Account?

Saving for college is daunting enough as it is, and then you have to worry about whether to save into a 529 Plan or a Custodial account.  Either can be used for education and both have their own benefits and drawbacks. When making a decision about which to use, you’ll want to consider the specific factors of your family situation.

A 529 Plan is tied to the state that sponsors it. Almost every state has a plan and you don’t have to live in the state to use their plan. You can compare the various plans at www.savingforcollege.com.  North Carolina’s plan has Vanguard funds, which are inexpensive, and there is currently a state tax deduction for residents that contribute to the plan up to $5,000 annually.

A custodial account on the other hand can be opened at any brokerage firm. There are no such deductions for contributions.

Comparison of 529 and Custodial Accounts


529 Plans

Custodial Accounts

Who Owns the Account?

The adult

The child

Who Controls the Account?

The adult

The adult only until the child’s age of majority

What is the Tax Character?

Investments grow tax-deferred and qualified withdrawals (for education) are withdrawn tax-free; non-qualified withdrawals come with a 10% penalty and a tax on earnings.

Investments are subject to the “kiddie-tax” but otherwise treated as any investment account, no special tax treatment.

What Can the Money Be Used for?

Qualified post-secondary education expenses to avoid the 10% penalty.

Anything that benefits the minor (you usually have to prove this)

Investment Options?

Usually index funds or mutual funds, restricted to the plan’s options


Can You Change your Mind about Giving the Money to the Minor?

You can change the beneficiary of the account to another member of the family.

No, it belongs to the child always.


If you feel confident there will be some qualified post-secondary education expense for your child or her siblings, the 529 plan is tax-friendly and a great choice, but it comes with some serious limitations.  If you want the freedom to use the funds however you want, the custodial account is the way to go.  But beware, the money will become the minor’s when they reach age 21.

Harli Palme, CFP®, CFA


Share this: