Custodial Account

Custodial Account

A custodial account is an account—at a bank, brokerage, or mutual fund company—opened and managed by an adult for the benefit of a minor. The adult (the custodian) controls transactions and investment decisions until the minor reaches the state-defined age of majority, at which point control transfers irrevocably to the beneficiary.

Key takeaways
* An adult manages the account for a minor; the minor is the legal owner.
* Gifts to the account are generally irrevocable.
* There are no contribution limits specific to custodial accounts, but gift-tax rules may apply.
* Account assets become the minor’s property at the age of majority and may affect financial aid eligibility.
* Custodial accounts are flexible in investments but are not as tax-advantaged as some education-specific accounts.

How custodial accounts work
* The custodian opens and manages the account in the minor’s name, deciding how to invest the funds and making transactions on the minor’s behalf.
* Contributions can come from parents, relatives, or others; once made, gifts typically cannot be revoked.
* The account may hold cash, stocks, bonds, mutual funds, and—in UTMA accounts—other asset types. Financial institutions often restrict highly speculative trading (e.g., margin, futures).
* When the minor reaches the state’s age of majority (commonly 18 or 21), legal control shifts to the beneficiary. If the child dies before that, the account typically becomes part of their estate.

Types of custodial accounts
* UGMA (Uniform Gifts to Minors Act): Allowed in all 50 states; typically limited to financial assets such as cash, securities, and insurance.
* UTMA (Uniform Transfers to Minors Act): Adopted by most states; can hold a broader range of property, including real estate, artwork, and certain intangible assets.
* Which to use depends on the types of assets you intend to transfer and state law.

Advantages
* Simplicity and low cost: Easier and less expensive to set up than a trust.
* Flexibility of use: Withdrawals must benefit the minor but aren’t limited to education expenses.
* No formal contribution limits: Anyone can contribute subject to gift-tax rules and annual exclusions.
* Broad investment options compared with some education-specific accounts.

Tax considerations
* The minor is generally treated as the owner for tax purposes. A portion of unearned income may be tax-free or taxed at preferential rates under rules commonly called the “kiddie tax,” but tax treatment and thresholds change annually.
* Custodial accounts are not tax-deferred like IRAs and are typically less tax-advantaged than certain education accounts (for example, 529 plans).
* Large gifts may trigger gift-tax reporting or use of the donor’s lifetime exclusion, depending on amounts and current tax law.

Disadvantages
* Financial aid impact: Assets are considered the child’s and can reduce need-based financial aid eligibility.
* Irrevocability: Gifts generally cannot be taken back and the beneficiary cannot be changed.
* Loss of parental control: At the age of majority, the child gains full legal control and can use the funds as they wish.
* Less favorable tax treatment compared with some alternatives (e.g., 529 plans); moving assets to those accounts may require liquidating investments.

Where custodial accounts are offered
* Most retail brokerages (online and traditional) offer UGMA/UTMA accounts.
* Banks commonly provide custodial checking and savings accounts.
* Terms, fees, and investment options vary by provider—compare platforms for fees, minimums, and educational resources.

Common questions
* Can money be withdrawn? Yes, the custodian can withdraw funds if the use is for the benefit of the minor.
* What happens when the child turns 18 or 21? Control and ownership transfer to the beneficiary at the age specified by state law.
* How do I open one? An adult opens the account in the minor’s name with a financial institution and is designated as the custodian until the age of majority.
* How is it taxed? The minor is generally taxed on account earnings; special rules apply to unearned income. Check current tax law or a tax advisor for up-to-date thresholds and rates.

Bottom line
Custodial accounts are a straightforward way to transfer and invest assets for a minor’s benefit, offering flexibility and ease of setup. They carry tax implications, are irrevocable, and can affect financial aid, so weigh these factors against alternatives like 529 plans or trusts before deciding which vehicle best meets your goals.