What is a Custodial Account?
Learn about custodial accounts, how they work, and their role in managing assets for minors or individuals who cannot manage their own accounts.
A custodial account is a type of account managed by a custodian on behalf of a minor or another individual who is unable to manage their own finances. These accounts are commonly used to hold and manage assets for children until they reach the age of majority, which typically varies by state (often 18 or 21 years old).
How Custodial Accounts Work
Custodial accounts are set up by an adult, typically a parent or guardian, who acts as the custodian. The custodian is responsible for managing the account, making investment decisions, and handling distributions. Once the minor reaches the age of majority, they gain full control over the account and its assets. Here’s how it works:
Account Setup: The custodian opens the custodial account on behalf of the minor or individual who is unable to manage the account. The custodian is legally responsible for managing the account until the minor reaches the designated age of majority.
Managing the Account: The custodian can make investment decisions, contribute funds, and withdraw money from the account as needed, all in the best interest of the beneficiary. Any withdrawals or distributions must ultimately benefit the minor.
Transfer of Ownership: Once the minor reaches the legal age in their state, the ownership of the account is transferred to them. At this point, the individual gains full control over the account and can manage it independently.
Types of Custodial Accounts
There are two main types of custodial accounts:
UGMA (Uniform Gifts to Minors Act) Accounts: These accounts allow for a wide range of assets, such as cash, stocks, bonds, and mutual funds, to be held for the minor.
UTMA (Uniform Transfers to Minors Act) Accounts: Similar to UGMA accounts, UTMA accounts allow a broader range of assets, including real estate or fine art, to be held in the minor’s name.
Benefits of Custodial Accounts
Custodial accounts offer several advantages for both the custodian and the beneficiary:
Asset Management for Minors: Custodial accounts allow minors to benefit from investments and assets that would otherwise be unavailable to them.
Educational Opportunity: These accounts provide an opportunity to teach children or other beneficiaries about managing finances and investing.
Tax Benefits: Depending on the income generated by the account, custodial accounts may offer some tax advantages. The first $1,100 of unearned income may be tax-free, and the next $1,100 may be taxed at the child’s tax rate.
Considerations
Irrevocable: Once assets are placed in a custodial account, they are considered a gift to the minor and cannot be taken back or changed.
Tax Treatment: Earnings in the account are taxed at the child’s tax rate, which may be more favorable. However, larger amounts of unearned income may be subject to the “kiddie tax,” where income is taxed at the parent’s tax rate.
Control: Once the minor reaches the age of majority, they gain full control over the account, which may not align with the custodian’s original intentions.
