Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / The Custodial 529 Strategy for Teens
Transcript
- Lucas: Let's talk about a 529 strategy that doesn't get nearly enough airtime — opening the account with your teenager as the owner, not just the beneficiary. Luna: Wait — can a minor actually own a 529? I thought the account owner had to be an adult. Lucas: Technically, yes. But here's the workaround: you use a custodial account first — an UTMA or UGMA account — and then convert that into a 529 with the teen as the owner once they're old enough to control it. Luna: So you're talking about the Uniform Transfers to Minors Act accounts. I've seen those used for gifting stocks to kids, but I didn't realize you could roll them into a 529. Lucas: Exactly. And the timing matters. Under the Uniform Transfers to Minors Act, the custodian — usually a parent — controls the money until the child reaches the age of termination, which in most states is 18 or 21. At that point, the kid gets full control. But if you convert the UTMA into a 529 before that happens, you can structure it so that the adult remains the custodian of the 529 until the beneficiary graduates, depending on the state plan. Luna: That sounds like it gives you the best of both worlds — tax-advantaged growth and some parental oversight. But what's the actual financial aid benefit here? Lucas: This is where it gets interesting. Under the old FAFSA rules, a 529 owned by a dependent student was counted as a parental asset, which meant it was assessed at a maximum of 5.64 percent. But a UTMA account owned by the student — that was counted as the student's asset, assessed at 20 percent. So converting the UTMA to a 529 effectively lowered the expected family contribution. Luna: But the FAFSA simplification that took effect in 2024 changed that, right? Now all assets from parents and students are treated more similarly. Lucas: You're right. Starting with the 2024–2025 FAFSA, the student's assets are no longer assessed at a higher rate. Both parental and student assets are excluded from the calculation if the family's adjusted gross income is below a certain threshold — around $60,000 for a family of four. Above that, the student's assets are still included, but at a flat rate of 20 percent, not the old sliding scale. However, a 529 plan — whether owned by the parent or the student — is still treated as a parental asset for FAFSA purposes, which is beneficial because parental assets are assessed at a lower rate. Luna: So the conversion still helps, but the advantage is smaller than it used to be. But there's another angle here — the behavioral one. Giving a teenager ownership of the account might make them more invested in saving. Lucas: That's actually the reason I find this strategy compelling. I spoke with a family in Ohio last month. They had set up an UTMA for their daughter when she was born, and by the time she turned 16, it had grown to about $18,000. They converted it into Ohio's 529 plan, with the daughter listed as the owner and the parents as custodians. The parents continued to contribute, but they also started showing the daughter the quarterly statements. She began asking about the investment options and even suggested increasing the contribution from her part-time job. Luna: So the 529 became a teaching tool. That's smart. And Ohio gives a state income tax deduction for 529 contributions — up to $4,000 per beneficiary per year. Did they get that deduction on the conversion? Lucas: Great question. The conversion itself is not a new contribution, so it doesn't qualify for the state deduction. But any additional contributions after the conversion do. In their case, they started contributing $4,000 a year after the conversion, which saved them about $150 annually in Ohio state taxes. Not a huge number, but it adds up. Luna: What about the risk that the teen takes the money out for non-education purposes? Once they're 18 or 21, they control the account. Lucas: That's the real downside. If the teen decides to withdraw the funds for something other than qualified education expenses, the earnings portion is subject to income tax and a 10 percent penalty. And there's nothing the parent can do to stop it. So you need to have a candid conversation with your kid about the consequences. Luna: But if the teen is already on board and contributing their own money, the likelihood of a rogue withdrawal probably drops. Lucas: Exactly. I'd argue that the teen ownership model works best when the teen has some skin in the game — either from earned income or from understanding the value of the account. In that Ohio family's case, the daughter was contributing about $1,000 a year from her summer job. She had a real sense of ownership. Luna: Let's talk about the mechanics. How do you actually convert an UTMA to a 529? Is it a rollover? Lucas: It's a two-step process. First, you liquidate the UTMA investments — you sell the stocks or mutual funds — and then you contribute the cash proceeds to a 529 plan. The beneficiary of the 529 must be the same person who was the beneficiary of the UTMA. And the account owner of the 529 is the custodian, but once the minor reaches the age of majority, the custodian role ends and the teen becomes the account owner. Luna: So the parent loses control at that point. That might be a dealbreaker for some families. Lucas: It should be. If you're not comfortable with your 18-year-old having full control over $20,000 or $50,000, this isn't the right strategy. But some state plans allow the custodian to remain on the account even after the beneficiary reaches majority. North Carolina's plan, for example, lets you add a joint owner. It's worth checking the specific plan rules. Luna: Right. So it's not a one-size-fits-all. But for families who have already opened an UTMA and are looking for a tax-advantaged way to repurpose that money for education, this is a clean solution. Lucas: And there's a tax consideration when you sell the UTMA assets. If the investments have appreciated, you'll owe capital gains tax on the sale. But for most families, the gains on a child's UTMA are taxed at the child's rate, which is usually zero percent for long-term capital gains if the child has little or no other income. So the tax hit is minimal. Luna: That's a big advantage. You're essentially harvesting gains at a low tax rate before the money goes into a tax-free growth vehicle. Lucas: Precisely. And if the UTMA has losses, you can harvest those losses and offset other gains. But that's a more advanced move. Luna: Speaking of advanced moves, can you convert a 529 back to an UTMA if you change your mind? Lucas: No. Once the money is in a 529, it's irrevocably in the 529. You can change the beneficiary to another family member, but you can't move it back to an UTMA. So it's a one-way door. Luna: That's a critical point. So you should only do this if you're confident the money will be used for education. Lucas: Right. But let's be realistic — if you already had an UTMA earmarked for college, this is just a more efficient vehicle. The question is whether you want the teen to have control. Luna: I'm curious about the numbers. What's the typical balance in an UTMA that families convert? Do you have any data? Lucas: According to a survey by the College Savings Foundation, the average UTMA balance for families who later convert to a 529 is around $15,000. But I've seen everything from $2,000 to over $100,000. The sweet spot is probably between $10,000 and $30,000 — enough to matter for college costs, but not so much that the teen could do serious damage if they withdraw it early. Luna: And what about the penalty if they do withdraw early? The 10 percent penalty applies to earnings only, not the principal, right? Lucas: That's correct. The principal contributions are always tax-free and penalty-free. The earnings are what get hit. So if the account has grown significantly, the penalty could be substantial. But if the teen only withdraws a small portion, the penalty might be manageable. Luna: Still, it's a risk. I think the key is communication. If you've raised a financially literate teenager, this can be a powerful tool. Lucas: Absolutely. And that's really the broader lesson here — 529 plans are often seen as just tax shelters, but they can also be vehicles for financial education. When a teenager sees their money growing tax-free and understands that it's for their future, they start to think differently about spending and saving. Luna: If this episode was useful to you and you want to keep it ad-free, buy me a coffee dot com slash fexingo helps. Lucas: Yeah, listener support is what keeps these conversations going without any commercial breaks. Appreciate you considering it. Luna: So to summarize the strategy: if you have an UTMA for a teen, consider converting it to a 529 before they turn 18. You get tax-free growth for education, a potential state tax deduction, and a chance to involve your kid in the process. Lucas: Just be aware of the control issue and the one-way door. And check your state's specific rules on custodian rights after the beneficiary reaches majority. For most families, it's a worthwhile move. Luna: I think the behavioral benefit is often overlooked. A 2019 study by the University of Kansas found that students who had a 529 account in their name were more likely to enroll in college and persist to graduation. There might be a psychological ownership effect. Lucas: That's a fascinating data point. And it aligns with what I've heard from financial planners — when kids have a tangible account they can check online, they're more engaged. One advisor I talked to said his teenage clients often check their 529 balance more frequently than their parents check their retirement accounts. Luna: So maybe the custodial 529 is as much a parenting tool as it is a financial one. Lucas: I think that's exactly right. And given the rising cost of college — average tuition and fees at a four-year public university are now over $11,000 per year — every little bit helps. If converting an UTMA can save a few thousand in taxes over the life of the account and get your kid more invested in their education, that's a win. Luna: Agreed. Thanks, Lucas. Good topic. Lucas: Yeah, thanks Luna. We'll see you next time.