Custodial Accounts for Minors: Your Complete Guide

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As a parent or guardian, one helpful thing you can do to get your kids ready for adulthood is to teach them how to save money. Another great way to help financially prepare them for the future is to open a custodial account. This type of supervised investment account offers an effective way to help grow savings for children who aren’t yet ready to start managing their own money. 

It’s no secret that investment accounts are more inflation-resistant methods of saving than low-interest savings accounts, but you can’t exactly open up a 401k for your kindergartener. Custodial accounts allow your kids to benefit from the money-growing power of investment accounts while they’re still minors. To determine whether one of these accounts might be right for your family’s financial situation, learn more about what custodial accounts are and how they work.

What Are Custodial Accounts?

Custodial accounts, like their name suggests, are any financial accounts that have custodians. Just like the custodians in a school or office care for the building, a custodian of a financial account cares for someone else’s assets. In financial terms, you could also refer to a custodian as a fiduciary. Regardless of the word you use, this is a trusted individual who looks out for someone else’s best financial interests by managing the assets in the account in a way that benefits the account owner. 

With a custodial account for a minor, the custodian is usually a parent, a guardian or another close relative. The minor is the account owner, and the custodian has limited rights to manage the account until the child becomes an adult. Account ownership transitions solely to the child when the child reaches the age of majority

Both parents can be the custodians over an account for one child. Although a checking account can be a custodial account, most people pursue custodial accounts for minors for the purpose of investing. You can open a custodial account just like any other bank account, but you do need to find a bank that offers custodial accounts. You then supply demographic information, such as dates of birth and Social Security numbers, for both yourself (and any other custodian) and your child.

How Do Custodial Accounts for Minors Work?

While a child is still a minor, their parents or custodians control the investment account. In most cases, the motivation for maintaining the account is to give the child a good financial footing when they reach adulthood. The child’s custodian can make deposits to the account and make any necessary decisions about how to invest the funds. The financial institution that holds the account takes care of investing the funds, shares earning statements with the custodian and may deduct brokerage fees.

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With their custodian’s help, a child can contribute some of their piggy bank funds to the custodial account. Just like any other investment account, the custodian can set up automatic contributions or invest sporadically when they have extra money. When the child becomes an adult, they can take complete control of the account and either spend the funds or continue to grow them by contributing their own savings.

Types of Custodial Accounts for Minors

Two main types of custodial accounts that exist were made possible by specific acts of law. These laws ensure that the investment accounts serve their purpose in providing the biggest possible benefits to the child. Otherwise, these investments might be lumped in with a parent’s income and potentially seized to satisfy certain debts. Therefore, it’s wise to use a custodial account specifically to build up savings for a child.

One type of custodial account for minors was made possible by the Uniform Gift to Minors Act (UGMA). These accounts can hold money and other financial assets like stocks, bonds, annuities and life insurance policies. 

The other type of custodial account for minors is made possible by the Uniform Transfer to Minors Act (UTMA). With UTMA accounts, you can assign assets like real estate, rare art, gold, silver, ownership of copyrights and entertainment royalties to a minor child. Note that UTMA accounts aren’t recognized by law in the state of South Carolina

There are also other ways to invest on behalf of your child for a specific purpose. For example, 529 savings plans help you put aside money to fund your child’s college education. You can also set up a trust fund and make a minor the beneficiary. 

Rules for Custodial Accounts for Minors

It’s important to remember that any money or other assets deposited into a custodial account belong to the child. In other words, what goes in often cannot come out. Assets in a custodial account must remain until the child reaches the legal age to withdraw them. Avoid making the mistake of viewing a custodial account for a minor as a rainy day fund that you can withdraw from in times of financial hardship. 

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For UGMA accounts, you’re allowed to contribute up to $16,000 per year without incurring taxes. Couples can contribute up to $32,000. If you exceed gifts of $16,000 in any year, your child will need to file and pay taxes that year, with your help. 

Children can earn up to $2,200 per year in a UTMA account before paying taxes on the money at their parents’ tax rate. UTMA accounts allow for the flexibility of making withdrawals. The general rule is that the withdrawals must be for the child’s direct benefit, and a financial institution can adopt more stringent rules. For tax and legal purposes, you may need to prove that the money is for some recognized need your child has, like primary school tuition or medical care, rather than household expenses, like food for your child to eat or rent where your child lives. 

In both UTMA and UGMA accounts, the money in the custodial account doesn’t count as income for either the custodian or the minor — as long as the minor is a child and the annual gift amount doesn’t exceed IRS limits. When applying for financial aid, all monies in a UTMA or UGMA account are considered the minor’s assets. 

Although a custodial account may require some careful planning, it can make a real difference in your child’s financial future. The funds your child receives from a custodial account once they reach adulthood can make attending college possible, serve as the seed money for your child’s first business or help your child with the downpayment on their first home.