Saving for a child’s education remains a major financial challenge, but one of the most common assumptions about college costs needs updating.
College tuition is not currently increasing at double digit rates every year.
For the 2025 to 2026 academic year, average published tuition and fees rose 2.9 percent for in state students at public four year colleges, 2.7 percent at public two year colleges, and 4.0 percent at private nonprofit four year institutions. Even so, the total cost of attendance can still be substantial. College Board estimates average annual student budgets of about $30,990 for an in state student at a public four year institution and $65,470 at a private nonprofit four year institution.
For families saving years in advance, those numbers make account selection important.
Taxes matter, but so does financial aid. The way money is owned can affect how it appears on the Free Application for Federal Student Aid, commonly known as the FAFSA. A savings account that looks attractive from a tax perspective may be less appealing if it is treated more heavily in the federal aid formula.
Three of the most familiar options are 529 plans, Coverdell Education Savings Accounts, and UGMA or UTMA custodial accounts. Each works differently.
529 College Savings Plans Offer Broad Tax Advantages and Growing Flexibility
A 529 plan is a tax advantaged education savings account authorized under Section 529 of the Internal Revenue Code.
These plans have existed since the 1990s, so they are no longer a new college savings option. They have, however, become considerably more flexible over time.
The central tax advantage is straightforward. Contributions are not deductible on the federal income tax return, although some states provide their own tax incentives. Investments can grow without current federal tax, and withdrawals are generally federally tax free when used for qualified education expenses.
Qualified uses now extend beyond traditional college tuition. Depending on the expense and applicable limits, 529 funds can be used for eligible postsecondary tuition, fees, books, supplies, equipment, certain room and board costs, registered apprenticeships, specified student loan repayments, qualified credentialing expenses, and certain elementary and secondary education costs. Federal rules expanded the permitted elementary and secondary school expense limit to $20,000 per beneficiary per year beginning in 2026.
Contribution ceilings are also much higher than those for Coverdell accounts. There is no single federal dollar ceiling that applies to every 529 plan. Individual programs establish maximum balances based on estimated education costs, and those limits vary by state.
What Happens if the Child Does Not Need All the Money?
Unused 529 money does not automatically disappear.
The account owner can generally change the beneficiary to another qualifying family member without triggering federal income tax. Funds can also be rolled into another eligible 529 account under applicable rules.
A newer option adds another layer of flexibility.
Certain unused 529 funds can now be transferred directly to a Roth IRA for the same beneficiary. The federal lifetime rollover limit is $35,000. The 529 account generally must have existed for at least 15 years, recent contributions are excluded, annual Roth IRA contribution limits still apply, and additional requirements must be satisfied.
If money is simply withdrawn for a nonqualified purpose, the consequences are more significant. The contribution portion is not taxed again, but the taxable earnings portion is generally subject to ordinary income tax and an additional 10 percent federal tax. Exceptions to the additional tax can apply in circumstances such as the beneficiary’s death, qualifying disability, or receipt of certain tax free educational assistance such as scholarships.
The Financial Aid Treatment Can Be Favorable
For dependent students, qualified education accounts such as 529 plans are generally reported with parent assets when parental information is required on the FAFSA. UGMA and UTMA accounts, by contrast, are treated as student assets when the student owns the account.
That distinction can matter.
Under the 2027 to 2028 federal Student Aid Index formula, eligible parental assets first receive any applicable asset protection allowance, then 12 percent of remaining discretionary net worth enters the parental calculation. The resulting adjusted available income is subject to progressive assessment rates that reach 47 percent. Student assets, in comparison, are generally assessed at 20 percent directly in the dependent student formula.
This is why the older rule of thumb that only about 6 percent of parent assets affect aid was commonly used. It approximated the maximum marginal effect of parental assets under the formula, but the actual calculation is more complicated and depends on income, asset allowances, and other FAFSA factors.
Some families are also exempt from asset reporting entirely under federal aid rules, so the effect of a 529 balance is not identical for every applicant.
UGMA and UTMA Accounts Offer Flexibility but Can Carry a Financial Aid Cost
Uniform Gifts to Minors Act and Uniform Transfers to Minors Act accounts are custodial accounts established for a minor.
Their greatest advantage is flexibility.
Unlike a 529 plan, the money is not restricted to education. Funds can generally be invested and used for the benefit of the child, subject to the applicable custodial rules. There is no specific annual contribution ceiling built into the account structure, although tax rules governing gifts still apply.
That flexibility comes with an important tradeoff.
Money contributed to an UGMA or UTMA account becomes the child’s property. The transfer is generally irrevocable. A custodian manages the assets while the child is a minor, but control must eventually pass to the beneficiary when the custodianship ends under the applicable state law.
That means a parent cannot later decide that the money should instead be reserved for a sibling or redirected to another goal.
Once the beneficiary obtains control, the money can generally be used for any lawful purpose, not necessarily college.
The Old Tax Rules Are Outdated
Older discussions of custodial accounts often cite rules saying that the first $800 of investment income is tax free, the next $800 is taxed at the child’s rate, and income above that level receives different treatment.
Those figures are obsolete.
For 2026, certain children with more than $2,700 of unearned income may be subject to the federal tax commonly known as the kiddie tax. Age, student status, earned income, and support tests also matter.
Custodial accounts therefore do not provide the broad tax free growth available inside a 529 plan.
FAFSA Treatment Is the Bigger Concern
For families expecting to seek need based federal student aid, account ownership may be even more important than the tax treatment.
Current FAFSA instructions treat an UGMA or UTMA account owned by the student as a student asset. The 2027 to 2028 Student Aid Index formula applies a 20 percent conversion rate to dependent student assets.
That can create a noticeably larger aid impact than a comparable amount held in a qualified education account treated as a parent asset.
The original claim that custodial assets were assessed at 35 percent is no longer correct. The current federal formula uses 20 percent for dependent student assets.
This does not mean UGMA and UTMA accounts are always poor choices. They can be useful when flexibility is more important than education specific tax advantages. But families concerned about future FAFSA eligibility should understand the ownership consequences before making large transfers.
Coverdell Education Savings Accounts Still Offer Useful Benefits but Have Tight Contribution Limits
The Coverdell Education Savings Account is another tax advantaged education account.
Like a 529 plan, contributions are not federally deductible, but investment earnings can grow tax free and qualified withdrawals can be free from federal income tax.
Coverdell accounts can also be used for qualified elementary, secondary, and postsecondary education expenses, which gives them useful flexibility for families planning education costs before college.
Their main limitation is contribution capacity.
Total annual contributions for one beneficiary generally cannot exceed $2,000 across all Coverdell accounts established for that beneficiary. That limit has remained unchanged for many years and is small compared with the amounts families may save in a 529 plan.
Income limits also apply.
For individual taxpayers, eligibility begins to phase out when modified adjusted gross income reaches $95,000 and disappears at $110,000. For married couples filing jointly, the phaseout generally runs from $190,000 to $220,000.
The original article’s statement that a person simply qualifies whenever income is below $110,000 or $220,000 misses this phaseout range.
Coverdell accounts also generally require the remaining balance to be distributed by the time the beneficiary reaches age 30 unless an exception applies, such as for certain special needs beneficiaries.
How Coverdell Accounts Affect FAFSA
For a dependent student who is required to provide parental information, current FAFSA instructions generally treat Coverdell accounts as qualified education savings accounts reported with parent assets.
That gives Coverdell accounts an important financial aid advantage over student owned UGMA and UTMA assets.
The tradeoff is capacity. A $2,000 annual contribution limit makes the Coverdell more useful as a supplemental education account than as the only savings vehicle for many families.
Which College Savings Account Has the Strongest Overall Advantages?
There is no single account that is right for every family, but the differences are substantial.
A 529 plan generally offers the broadest combination of high contribution capacity, tax free qualified withdrawals, beneficiary flexibility, expanding qualified uses, and comparatively favorable FAFSA treatment for dependent students.
A Coverdell ESA offers many of the same tax principles and can cover a wide range of education expenses, but the $2,000 annual contribution limit and income restrictions reduce its usefulness for larger savings goals.
UGMA and UTMA accounts provide the greatest freedom over how the money is ultimately used, but they sacrifice the dedicated education tax treatment and may have a more significant impact on federal aid because the assets belong to the student.
For families concerned about financial aid, the ownership of an account should be considered alongside investment returns and tax benefits.
It is also important to remember that FAFSA determines federal aid under federal rules. Colleges, states, and private scholarship programs can use additional formulas or request other financial information. The result at a particular institution can therefore differ from the federal calculation.
The most useful college savings strategy is usually the one that balances education goals with the family’s broader finances, including emergency savings, retirement planning, taxes, investment risk, and the possibility that a child may receive scholarships or choose a less expensive education path.
Starting early still matters. But choosing where the money is saved can matter almost as much as deciding how much to save.
