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If you're looking for a way to hold gifts of cash for your child, both a savings account and a 529 plan should come to mind.

But these accounts have very different purposes — each of which limits how the money can be spent. And while it is often recommended that you open at least one of these accounts when you have a baby on the way, you can start a 529 plan at any time, according to the IRS.

So, how do you know when you're ready to start a 529 versus just continuing to house your child's money in savings?

Opening a Custodial Savings Account

A custodial savings account is a safe vehicle to store your child's money while also allowing it to grow over the years through earned interest.

Let's look at why you would or would not want to store money in a savings account:

  • Custodial Savings Account Pros: Setting up a custodial savings account is easy and any kind of investment can be deposited into the account. Interest rates vary based on the bank, but there's no risk of losing the money thanks to the FDIC Deposit Insurance carried by most banks. While money can be withdrawn from this account at any time, the child (while he or she is underage) must get permission from the person that opened the account to do so. Also, the money can only be used to benefit the child, until he or she comes of age, at which point they're able to spend the money on anything from college to a down payment on a house. Be sure to find out if there's a minimum balance required for the savings account — you may be charged monthly fees if you drop below the minimum.
  • Custodial Savings Account Cons: There are no tax benefits to owning this type of account. In fact, custodial savings accounts are taxed as ordinary income; however, the rate is determined by the child's tax bracket. But you can rest assured that your child's money is not likely to earn enough interest to pay taxes on for many years (refer to this IRS publication 929 for more info). Another con is that the child will receive full control over this account to spend on whatever they would like once they reach the age of majority — 18 or 21, depending on which state you live in.

Starting a 529 Plan

Perhaps you'd like to see your child's money grow faster and you have a distinct purpose for the accumulation: to send them to college.

Then a 529 plan account may be what you're looking for:

  • 529 Plan Account Pros: A type of investment account, a 529 gives you a bit more control over the money's intent because there may be stiff taxes and penalties if the money is not used for secondary education expenses. If your child doesn't end up going to college, you can switch the beneficiary of the account to your next child or a different family member, as the account is owned by you instead of the child. As a type of investment, it's also possible to make more money with a 529 than you would with a savings account. That's before factoring in the significant tax benefits for these plans, including tax-free withdrawals for qualified education expenses and growth.
  • 529 Plan Account Cons: The only qualified use of the money is for an accredited post-secondary school in the U.S. and some accredited international schools. What happens if your child doesn't end up going to college? While you can do everything in your power to give them the resources, mindset and help to get them there, you still can't force them to go. So, there's no guarantee. If the money ends up being used for something else, then you'll face stiff penalties plus federal income tax assessments on the earnings. It is also important to note that as an investment account, your return isn't guaranteed, which means you can lose some or all of the money.

In a nutshell, one is an account that pays guaranteed interest and allows your child to spend their money however they wish when they reach the age of majority, while the other is an investment account intended for qualified educational expenses that only you retain control over.

You'll know which one to start once you decide what you intend the money to be used for once your child takes it over.


This information and recommendations contained herein is compiled from sources deemed reliable, but is not represented to be accurate or complete. In providing this information, neither KeyBank nor its affiliates are acting as your agent or is offering any tax, accounting, or legal advice.

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