What's the difference between a custodial account (UTMA/UGMA) and a 529 plan?

The core tradeoff: a 529 plan gets a real federal tax advantage but restricts how the money can be used; a UTMA/UGMA custodial account can be used for anything but legally becomes the child's own money at adulthood, with no matching federal tax break. Both are common ways to save or invest on a child's behalf, and many families end up using both for different purposes.

529 plan: tax-advantaged, but restricted to education

• Tax-free growth and withdrawals — earnings grow tax-free federally, and withdrawals are tax-free at the federal level when used for qualified education expenses (tuition, fees, room and board, books), including up to $10,000/year in K-12 tuition and, under a SECURE 2.0 Act provision, up to $35,000 in lifetime rollovers to the beneficiary's own Roth IRA under specific conditions.
• Non-qualified withdrawals are penalized — the earnings portion of a withdrawal not used for qualified expenses is subject to ordinary income tax PLUS a 10% federal penalty.
• The account owner (usually the parent) retains control indefinitely — even after the child turns 18, and can change the named beneficiary to another eligible family member if plans change.
• Many states offer a state income tax deduction or credit for contributions to that state's own 529 plan — check your specific state's rules.

UTMA/UGMA custodial account: flexible, but irrevocable

• Any use that benefits the child — a car, a computer, a gap-year trip, a business, college — there's no restriction on what the funds are used for, unlike a 529.
• The gift is irrevocable — once money or assets go into a UTMA/UGMA account, they legally belong to the child. A parent/custodian manages the account until the child reaches the state's specified age of majority, but cannot simply take the money back.
• No special federal tax-advantaged growth — the account is subject to the 'kiddie tax' rule (IRC §1(g)): a portion of the child's unearned income is taxed at the child's own rate, and any amount above a threshold set annually by the IRS is taxed at the parent's marginal rate instead, rather than at simple flat child-level rates.
• Control legally transfers to the child at the state's age of majority — commonly 18 or 21 depending on the state — after which they can spend it however they choose, with no legal say from the parent.

The financial-aid difference — this one surprises a lot of families

For FAFSA purposes, a parent-owned 529 plan is assessed as a parental asset, counted at a maximum rate of 5.64% toward the Expected Family Contribution. A UTMA/UGMA custodial account is legally the child's own asset, and student-owned assets are assessed at a much higher rate — up to 20% — under the federal financial aid formula. In practice, this means a custodial account can reduce a family's eventual financial-aid eligibility significantly more than an equivalent balance held in a 529.