Key Takeaways
- Adult manages account for minor's benefit.
- Assets legally owned by the minor.
- Funds transfer at age of majority.
- Two types: UGMA and UTMA accounts.
What is Custodial Account?
A custodial account is a financial account set up by an adult (the custodian) to hold and manage assets for a minor beneficiary until they reach the age of majority. These accounts can be opened at banks, brokerages, or investment firms, allowing the custodian to control investments while the assets legally belong to the child from the start.
This structure ensures the custodian acts in the best interest of the minor, managing deposits, withdrawals, and investment decisions responsibly.
Key Characteristics
Custodial accounts have distinct features that make them suitable for gifting and managing assets for minors.
- Ownership: Assets are irrevocably gifted to the minor, who gains full control at the account’s termination age.
- Custodian Role: The custodian controls the account but must use funds solely to benefit the child.
- Types: Mainly UGMA and UTMA accounts, with UTMA allowing a wider range of assets like real estate.
- Tax Implications: Earnings may be subject to the Kiddie Tax rules, affecting unearned income.
- Transfer Age: Typically between 18 and 25, depending on state law.
- Account Management: Often handled through online brokerages or banks for ease and accessibility.
How It Works
To establish a custodial account, a custodian opens the account at a financial institution and deposits assets irrevocably for the minor. The custodian manages all transactions, including investing in stocks, bonds, or mutual funds, always prioritizing the beneficiary's financial needs.
When the minor reaches the designated age, the account's control automatically transfers to them. This process requires the custodian to initiate the transfer, ensuring compliance with state-specific laws. Custodial accounts differ from trusts in that they are simpler to set up but provide less flexibility in terms of distribution and restrictions.
Examples and Use Cases
Custodial accounts serve many practical purposes for families and individuals looking to gift or invest for minors.
- Education Funding: Parents or grandparents may invest for college expenses, similar to other savings vehicles but with fewer restrictions.
- Gift of Securities: Gifting stocks through custodial accounts is common; for example, investing in companies like Delta or Apple can provide long-term growth for a child's future.
- Financial Education: Custodial accounts offer a hands-on way for minors to learn about investing and money management once they assume control.
- Asset Transfers: These accounts allow for easy transfer of assets without the complexity of trusts, useful for straightforward gifting.
Important Considerations
Before opening a custodial account, consider that these gifts are irrevocable, meaning you cannot reclaim the assets once transferred. The beneficiary assumes full control at the legal age, which may lead to unplanned spending if not discussed beforehand.
Additionally, custodial assets count toward the minor's financial aid calculations, potentially reducing eligibility. For tax-efficient investing within custodial accounts, you might explore options like backdoor Roth IRA strategies or low-cost index funds found in our best low-cost index funds guide to optimize growth.
Final Words
Custodial accounts provide a straightforward way to transfer assets to a minor while maintaining control until they reach adulthood. Review your state’s options between UGMA and UTMA accounts, then compare custodial account providers to find the best fit for your goals.
Frequently Asked Questions
A custodial account is a financial account opened by an adult for a minor, where the adult (custodian) manages the assets until the minor reaches adulthood. The assets legally belong to the minor from the start, and the custodian must act in the child's best interest.
The custodian, often a parent or guardian, manages the account and makes all financial decisions for the minor's benefit. The minor gains full control of the account once they reach the age of majority, typically between 18 and 25 depending on state law.
Custodial accounts under UGMA allow cash, stocks, bonds, and life insurance, while UTMA accounts can hold those plus physical assets like real estate and jewelry. Availability of UTMA accounts varies by state.
UGMA accounts are available in all states and hold financial assets, whereas UTMA accounts permit a broader range of assets, including physical property, but are not available in every state. Both are irrevocable gifts to the minor.
Yes, anyone can contribute to a custodial account by gifting assets to the minor, but these gifts are irrevocable and must be managed by the custodian solely for the child’s benefit.
If the custodian dies, a successor custodian named in a will or by state law takes over management. If the beneficiary dies before gaining control, the assets become part of the minor’s estate.
Custodial accounts can be opened at banks, brokerage firms like Fidelity or Edward Jones, and mutual fund companies. The custodian manages the account until the minor reaches the age of majority.
Custodial accounts offer a simple way to save or invest for a child’s future with tax advantages and flexibility in asset types. They also ensure funds are used for the child's benefit until they assume control.
