Can you transfer funds from custodial accounts to a 529 plan � and vice versa?

You can move money from a custodial account, such as a UGMA (Uniform Gifts to Minors Act) or a UTMA (Uniform Transfers to Minors Act), to a 529 plan. There are two primary reasons to consider doing so. One is taxes. Investment earnings in a 529 grow tax-deferred, and withdrawals, including any earnings, are tax-free when they are used for qualified education expenses. In a custodial account, investment income over a certain threshold may be taxable. The second reason is that 529 assets are treated more favorably from a financial aid perspective than UGMA/UTMA assets. When applying for federal financial aid, since 529 assets are generally considered parental assets, only 5.64% of which are considered when calculating the Expected Family Contribution (EFC), while UGMA/UTMA assets, which are considered the student's assets, are factored in at 20%. (see more below ). 4 There are a few downsides to this shift, however, including potential capital gains taxes on any profits when you sell UGMA/UTMA assets to make the transfer. Plus, when you transfer a custodial account to a 529, you create what's called a custodial 529 account, which has certain restrictions. For one, you cannot change the beneficiary, as you can with a traditional 529 and the beneficiary becomes the account owner upon reaching the age of termination based on the state the UGMA/UTMA was established under. Compare custodial accounts and 529s here.

529 college savings plans: An essential guide

Q: Can a child benefit from having more than one 529?

The short answer is yes � a child can be the beneficiary of multiple 529 plans. Why would parents or grandparents want to contribute to separate 529 plans? As noted in the previous question, state tax benefits may come into play if multiple individuals that reside in different states are contributing. Another reason is control: As the owner, the person who sets up a 529 plan can decide how the assets are invested and when distributions should be made. The owner can also change the account beneficiary, something you might want to do, for example, if the original beneficiary no longer needs the funds. Although most 529 plans provide a diversified mix of investments to choose from, having more than one 529 plan could give you more investment options and access to additional investment managers. While not common, another reason for opening multiple 529s for the same beneficiary: contribution caps . Each state sets account balance maximums, which generally range from $300,000 to over $500,000. The maximum applies to the combined balances of all accounts for the same beneficiary in that state's 529 plan. By opening an additional 529 plan in another state, you might be able to invest more than what your state allows.

Q: Can you roll over a 529 plan?

Within any 12-month period, IRS rules allow one income tax-free rollover of a single 529 account into another for the same beneficiary. Two reasons you might consider a rollover: You've moved, and your new state offers a tax deduction for contributions to qualifying in-state 529 plans. By rolling the 529 from your old state into your new home state's plan, you can keep new and old contributions together in one account. Or you may have multiple 529s and want to consolidate them to make tracking and managing your savings easier. You cannot, however, roll a 529 plan account into an IRA or any other retirement plan. However, you can also rollover a 529 account into another account for a member of the family of the designated beneficiary.

Q: Could a 529 plan affect financial aid?

The financial-aid formulas used to determine need-based federal grants, loans and scholarships treat assets and income differently, with assets playing less of a role than income does. Parents are typically expected to contribute only 5.64% of assets annually toward college, including 529 plans (but not including retirement savings or the equity in your primary residence). Students are expected to chip in 20% of their assets for college costs, including UTMA and UGMA custodial accounts � making a 529 plan a better savings choice if aid eligibility is a priority. You are not required to report a 529 owned by a grandparent on the FAFSA (Free Application for Federal Student Aid), so those assets don't figure into aid formulas. (Keep in mind, however, that some private colleges use different financial aid forms that may treat 529s differently.) However, a 529 account owned by a grandparent still has the potential to reduce a grandchild's need-based aid eligibility. That's because distributions from the 529 account are considered non-taxable income to the student in the following year when completing your FAFSA, increasing the amount of assets held in their name. It is important to note that there have been recent changes to the FAFSA application over the next couple of years that will eliminate this issue going forward.

Answers to key questions about the tax-advantaged accounts that can help families save for college and other education costs.

The value of a college education may be priceless — but paying for it can be a daunting financial challenge. One tool that can help: a state-sponsored 529 savings plan. Richard Polimeni, Education Savings Programs executive for Bank of America, fields the most frequently asked questions about 529s.

Estimate how much to save with the College Planning Calculator.

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What are the benefits of a 529 plan?

A 529 plan provides a tax-advantaged way to invest for college and even for a private elementary and secondary school education. The money you contribute to a 529 plan isn't tax deductible for federal income tax purposes, but depending on where you live you may qualify for a state income tax deduction for contributions made to your home state plan. Investments in the 529 account have the potential to grow tax-deferred, and withdrawals, including any earnings, used to pay for qualified education expensesFootnote ¹ are tax-free. Almost anyone can open and contribute to a 529 plan — there are no income restrictions — and 529 contribution limits are high enough to allow families to plan for the rising cost of college.

What counts as a qualified 529 expense?Footnote ¹

Withdrawals from a 529 plan are fully tax-free when used to pay for qualified education expenses. Those generally include anything a student needs to attend an accredited college, university or vocational or technical school — tuition and required fees, room and board,Footnote ² books and equipment, and computer expenses, for example. Other qualified expenses include the costs associated with the participation in a certified and registered apprenticeship program; withdrawals of up to $10,000 per year to pay for tuition at an eligible private, religious or public K-12 school; and payments toward student loans of the beneficiary and each sibling of the beneficiary, up to a lifetime maximum of $10,000. This lifetime maximum applies separately to the account beneficiary and each sibling of the beneficiary.

While the rules cover a wide range of education costs, some expenses aren't considered qualified. Those include the cost of traveling to and from school, college test prep or entrance exam fees, health insurance purchased through the school and fees for extracurricular activities.

The earnings portion of non-qualified withdrawals is subject to federal and possibly state and/or local income taxes as well as a potential 10% additional federal tax.

Can you open a 529 account for a grandchild?

Yes, you can open a 529 account for a grandchild. It doesn't matter where your grandchildren plan to attend school. Before you select a 529 plan, be sure to check for state tax or other state benefits available through your home state or your grandchildren's home state 529 plan. In addition, almost anyone can open a 529 plan, including friends and other relatives.

A 529 can also be an important estate planning tool. You can set up multiple 529 plans for your beneficiaries. If set up a 529 plan for one grandchild and that grandchild decides not to use the funds for college, you may be able to change the beneficiary to another grandchild (or certain other members of the original grandchild's family as defined in the Internal Revenue Code without incurring income taxes. With a 529 plan, you can also make a contribution of five times the annual gift exclusion amount in one year by filing an election on a federal gift tax return if certain conditions are met.Footnote ³

Contributions made to a 529 plan generally are considered completed gifts and generally do not count as part of your federal taxable estate. However, if you are the account owner, you may still exercise control over the money, including choosing among the investments offered by the plan.

Can a child benefit from having more than one 529?

The short answer is yes — a child can be the beneficiary of multiple 529 plans. Why would parents or grandparents want to contribute to separate 529 plans? As noted in the previous question, state tax benefits may come into play if multiple individuals who reside in different states are contributing. Another reason is control: As the owner, the person who sets up a 529 plan can decide how the assets are invested and when distributions should be made. The owner can also change the account beneficiary, something you might want to do, for example, if the original beneficiary no longer needs the funds.

Although most 529 plans provide a diversified mix of investments to choose from, having more than one 529 plan could give you more investment options and access to additional investment managers. While not common, another reason for opening multiple 529s for the same beneficiary: contribution caps. Each state sets account balance maximums, which generally range from $300,000 to $550,000. The maximum applies to the combined balances of all accounts for the same beneficiary in that state's 529 plan. By opening an additional 529 plan in another state, you might be able to invest more than what your state allows.

Can you transfer funds from custodial accounts to a 529 plan?

You can move money from a custodial account, such as a UGMA (Uniform Gifts to Minors Act) or a UTMA (Uniform Transfers to Minors Act), to a 529 plan. There are two primary reasons to consider doing so. One is taxes. Investment earnings in a 529 grow tax-deferred, and withdrawals, including any earnings, are tax-free when they are used for qualified education expenses. In a custodial account, investment income over a certain threshold may be taxable. The second reason is that 529 assets are treated more favorably from a federal financial aid perspective than UGMA or UTMA assets. When applying for federal financial aid, since 529 assets are generally considered parental assets, only 5.64% of which are considered when calculating the new Student Aid Index (which replaces the existing Expected Family Contribution), while UGMA/UTMA assets, which are considered the student's assets, are factored in at 20% for purposes of the federal financial aid calculation. (See more below).Footnote ⁴

There are a few downsides to this shift, however, including potential capital gains taxes on any profits when you sell UGMA or UTMA assets to make the transfer. Plus, when you transfer a custodial account to a 529, you create what's called a custodial 529 account, which has certain restrictions. For one, you cannot change the beneficiary, as you can with a traditional 529, and it is your obligation to turn the assets over to the designated beneficiary when they reach the termination age based on the state the UGMA or UTMA was established under.

Compare custodial accounts and 529s.

Can you roll over a 529 plan?

Within any 12-month period, IRS rules allow one tax-free rollover of a single 529 account into another 529 account for the same beneficiary. Two reasons you might consider a rollover: You've moved, and your new state offers a tax deduction for contributions to qualifying in-state 529 plans. By rolling the 529 from your old state into your new home state's plan, you can keep new and old contributions together in one account. Or you may have multiple 529s for other reasons and want to consolidate them to make tracking and managing your savings easier. Finally, you can roll a 529 account into another 529 account for a member of the family of the designated beneficiary.

Could a 529 plan affect financial aid?Footnote ⁴

The financial aid formulas used to determine need-based federal grants, loans and scholarships treat assets and income differently, with assets playing less of a role than income does. Parents are typically expected to contribute only 5.64% of assets annually toward college, including 529 plans (but not including retirement savings or the equity in your primary residence).

Students are expected to chip in 20% of their assets for college costs, including UTMA and UGMA custodial accounts — making a 529 plan a better savings choice if aid eligibility is a priority. Starting with the 2024-25 school year, you will not be required to report a 529 owned by a grandparent on the FAFSA (Free Application for Federal Student Aid), so those assets won't figure into aid formulas. (Keep in mind, however, that some private colleges use different financial aid forms that may treat 529s differently.)

Financial aid rules may change, and the rules in effect at the time the beneficiary applies may be different. For more information on federal aid, please go to the Department of Education's website at www.ed.gov.

What happens to a 529 if all the money isn't used?

If your child doesn't go to college or doesn't need all the 529 funds, perhaps due to scholarships, you have a few options for using what's left. One is to transfer or roll over the 529 account to a new beneficiary. To be an income tax-free rollover, that person must be a member of the original beneficiary's family, such as siblings (including stepsiblings), parents, spouse, children, first cousins, nieces and nephews. You can also name yourself as a beneficiary (assuming you are a family member of the beneficiary) and use the funds for your own education or training, either in your current career or as a way to begin a new one. This strategy isn't possible, however, for custodial 529 plans — as that beneficiary designation is irrevocable.

If your child receives a scholarship, grant or attends a U.S. military academy, you may withdraw an amount equal to the scholarship/grant (or the costs of advanced education attributable to attendance at the military academy) from the 529 account without having to pay the 10% additional federal tax; you will owe only the federal ordinary income taxes on the earnings portion of the withdrawal. State and local income taxes may also apply. The 10% additional tax is also waived if the beneficiary dies or becomes disabled. You can also roll over a 529 into an ABLE account (a tax-advantaged savings account that benefits those who are disabled), subject to ABLE contribution limits. Beginning in 2024, you can also roll over 529 assets to a Roth IRA for the beneficiary if the 529 account has been open for at least 15 years and meets certain other conditions.

Also keep in mind that there aren't any distribution deadlines on 529 account assets, so assets can remain in an account and be used to fund the beneficiary's graduate or other schooling at a later date. Finally, you can close the account and take a non-qualified withdrawal. In that case, federal income taxes, state and local income taxes, and the potential additional 10% federal tax on earnings will apply.

Next steps

Use the college savings guide to help you develop a game plan to fund college
Learn about investing in a 529 plan to help you save for education expenses
These resources can help you save and invest for a child's education

Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

Before you invest in a Section 529 plan, request the plan's official statement from your Merrill Financial Solutions Advisor and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the plan, which you should carefully consider before investing. You should also consider whether your home state or your designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection from creditors that are available only for investments in such state's 529 plan. Section 529 plans are not guaranteed by any state or federal agency.
Footnote ¹ To be eligible for favorable tax treatment afforded to the earnings portion of a withdrawal from a Section 529 account, such withdrawal must be used for "qualified higher education expenses" as defined in the Internal Revenue Code. The earnings portion of a withdrawal that is not used for such expenses is subject to federal income tax and may be subject to a 10% additional federal tax as well as applicable state and local income taxes. The additional tax is waived under certain circumstances. Qualified higher education expenses include tuition, fees, books, supplies and equipment required for enrollment or attendance of the beneficiary at an eligible educational institution; certain room and board expenses; special needs services incurred in connection with enrollment or attendance at an eligible educational institution; and computers or peripheral equipment, computer software, or internet access and related services that are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution. The beneficiary must be attending an eligible educational institution at least half-time for room and board expenses to be considered a qualified higher education expense, subject to limitations. Institutions must be eligible to participate in federal student financial aid programs to be eligible educational institutions. Some foreign institutions are eligible. You can also take a federal income tax-free distribution from a 529 account of up to $10,000 per calendar year per beneficiary from all 529 accounts to help pay for tuition at an eligible elementary or secondary public, private or religious school. Qualified higher education expenses include expenses for fees, books, supplies and equipment required for the participation of a beneficiary in an apprenticeship program registered and certified with the Secretary of Labor under the National Apprenticeship Act and amounts paid as principal or interest on any qualified education loans of the beneficiary or sibling of the beneficiary, up to a lifetime maximum of $10,000 per individual. Distributions with respect to the loans of a sibling of the beneficiary will count toward the lifetime limit of the sibling, not the beneficiary. Such repayments may impact student loan interest deductibility. State tax treatment may vary for distributions to pay for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school; apprenticeship expenses; and payment of qualified education loans.

Footnote ² The beneficiary must be attending an eligible educational institution at least half-time for room and board to be considered an eligible expense.

Footnote ³ Contributions between $17,000 and $85,000 ($34,000 and $170,000 for married couples electing to split gifts) made in 2023 can be prorated over a five-year period without incurring federal gift tax or using your federal gift tax exemption amount by filing an election on a timely filed federal gift tax return. If you contribute less than the $85,000 ($170,000 for married couples electing to split gifts) maximum, additional contributions can be made without you being subject to federal gift tax or using any of the account owner’s federal gift tax exemption, up to a prorated level of $17,000 ($34,000 for married couples electing to split gifts) per year. Federal gift tax or the use of the account owner’s federal gift tax exemption amount may result if a contribution exceeds the available annual gift tax exclusion amount remaining for a given beneficiary in the year of contribution. If the account owner makes an election to prorate a gift and dies before the end of the five-year period, a prorated portion of the contribution may be included in the account owner’s estate for federal estate tax purposes. Please consult your tax and/or legal advisor for guidance.

Footnote ⁴ This is based on current interpretation of federal financial aid rules. Financial aid rules may change, and the rules in effect at the time the beneficiary applies may be different. For more information, please go to the Department of Education's website.

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