Custodial Account For Your Child [A Good Idea?]

custodial account

Are you looking for ways to save money for your kids’ future? If so, then you should consider opening a children’s custodial account. Custodial accounts are savings accounts that are specifically designed for minors.

Custodial accounts are usually managed by financial institutions such as banks or credit unions. These accounts are typically opened by parents who want to provide their children with a safe place to store their money while teaching them the value of compound interest at the same time.

What Is A Custodial Account?

A custodial account is a financial account such as a savings account that an adult controls for a minor under the age of 18 or 21, depending on the state’s regulations where they reside. The custodian must authorize any transactions impacting the account, such as purchasing or selling stocks.

In a larger sense, a custodial account can refer to any fund managed on behalf of a subscriber by a fiduciary, such as an eligible employee’s employer-based pension plan handled by a plan administrator. A trustee has a moral and legal responsibility to act in the beneficiaries best interests.

State regulations govern the age of the majority and the designation of guardians and alternate custodians.

Because there are no payments or contribution limits and no withdrawal penalties, custodial accounts offer a lot of flexibility. In these custodial accounts, no payouts are required at any time. In addition, a gift to a custodial account is considered an irrevocable gift and cannot be modified or withdrawn. 

How Does A Custodial Account Operate?

A custodial account, once opened, functions similarly to any other bank or stock account. The custodian, also known as the designated manager or financial adviser, makes the investment decisions. The account manager is free to make further contributions to the investment.

Custodial accounts, as previously stated, can invest in a wide range of assets. But, on the other hand, the financial services companies are unlikely to enable the manager to trade on margin or buy futures, swaps, or other investments using the account.

Ownership of the account legally transfers from the custodian to the specified beneficiary when the majority reaches the legal age of adulthood; the age of majority varies from state to state. At this point, they claim complete control and exploitation of the assets. The account will become part of the child’s estate if the minor dies before adulthood.

Who Can Open A Custodial Account?

who can open a custodial account

The custodial account does not have to be utilized by a parent to save for their child. Grandparents, guardians, aunts, uncles, and other relatives can use custodial accounts to assist a child in saving money. So said, it makes no difference what kind of connection you have.

For example, suppose you have a special child in your life and want to assist them in achieving financial independence when they reach maturity. In that case, you can form a custodial account for them or contribute to one that someone else has already established.

On the other hand, Custodial accounts have had restrictions on donating to an existing account until recently.

A parent or guardian can set up a custodial account, and then many individuals can contribute anytime they choose.

That means aunts, uncles, cousins, friends, coworkers, and anyone else may contribute to a child’s custody account without having to make several payments, speak with banks, or involve a large number of individuals.

It is considerably easier to give money as a gift, and it also implies that your child’s savings capacity will grow tenfold because anyone can contribute towards the account.

Types Of Custodial Accounts

The Uniform Transfers to Minors Act (UTMA) and the Uniform Gift to Minors Act (UGMA) are the two types of custodial accounts. The form of adult-controlled investment account you provide is the crucial distinction between them. 

UTMA accounts can include almost any type of investment, including real estate, intellectual property, proprietary information, and pieces of art. However, cash, stocks, bonds, mutual funds, pensions, and insurance policies are the only financial assets allowed in UGMA accounts. UGMA accounts are permitted in every state in the United States. South Carolina, on the other hand, does not accept UTMA accounts.

Custodial accounts are opened using the child’s name under UTMA and the previous version UGMA, with a specified trustee, the child’s parent, or guardian. The firm that houses the account sets the initial deposits, minimum account balances, and interest rates.

Benefits Of Custodial Accounts

benefits of a custodial account

Custodial accounts offer a great deal of freedom. There are no annual contribution limits on income or contributions, and there are no requirements to make monthly payments at any time. Furthermore, there are no costs associated with withdrawals.

All funds withdrawn prior to the age of majority must be spent for the minor’s benefit. These broad criteria do not apply to school costs, as with college funds programs. The funds may be used any way the custodian sees fit as long as the beneficiary benefits, such as providing a place to live and paying for clothing.

A trust fund is more expensive and difficult to set up than a custodial account. Therefore, the UGMA and UTMA guidelines were designed to simplify the transfer of assets to their children without setting up a trust. 

Tax Advantages For Custodial Accounts

Custodial accounts provide certain tax advantages; however, they are not tax-deferred like IRAs. The gains are taxed at the minor’s rate up to a particular level since the IRS considers the young child the account’s owner. A specific amount of unearned income is taxed at a reduced rate for any child under 19 who files a tax return with their parents.

The initial deposit of $100 of personal income deposited will be tax-free in 2022, while any amount up to $1,100 will be taxed at 10%. In addition, $2,200 will also be taxed at the custodian’s rate.

After reaching the age of majority in their state, the juvenile will be able to file their tax return. At this age, all account profits are liable to the beneficiary’s tax allowance in effect at the time of filing. 

In addition, in 2022, a person can make a tax-free contribution to an account with an annual limit of up to $15,000 ($30,000 for a husband and wife filing jointly). 

Downsides Of Custodial Accounts

Having a custodial account has its advantages and disadvantages. Because the holdings are considered investments, they may lower a child’s qualification for financial assistance when applying for funds for college. It might also make it more difficult for them to receive other federal support.

Any payments or donations made to the account are irreversible and cannot be amended or canceled. When the child reaches the age of majority, the child obtains the entirety of the account’s holdings. Many college fund options, such as a defined contribution plan, provide parents financial control. 

Custodial accounts are not tax-free in the same way that other accounts are. For example, a custodian may transfer money to a qualifying 529 plan to reduce the tax burden. However, the custodian must first liquidate any non-cash assets in the custodial account. 

Furthermore, the beneficiary of a custodial account cannot be changed, but the beneficiary of a 529 education plan can be changed with some restrictions. In the minor’s name, a custodial account is created. The beneficiary cannot be altered since the charge is irrevocable, and no gifts or donations to the fund may be canceled.

Is It A Good Idea To Open A Custodial Account For Your Kids? 

should you open a custodial account for your child

A custodial account is an excellent method to put money down for your child’s future. That is true whether you are saving for higher education or not. As your child matures, so will their financial situation. Tax advantages associated with custodial accounts might be a bonus.

That being stated, you should carefully consider all of your alternatives before opting for a custodial account. Examining the influence of these accounts on financial aid is one of the most critical aspects of such a choice. When a kid asks for financial help, funds in a custodial account are included as assets. Therefore, if you have a large amount of money in the account, your child may miss out on thousands of dollars in financial assistance.

Another consideration is the minor for whom you are creating the account. When a juvenile reaches the age of majority, they have complete control over the fund and its assets. However, if you are concerned that your child may not spend money responsibly when they turn 18 or 21, in such a case, this account might not be for you. 

How To Open A Custodial Account

To create a custodial account, you need your child’s name, birthday, and social security number. Once set up, An adult custodian can control all of the account’s activity, which centers on deposits and picking which assets to invest. You can also withdraw cash at any time, but the funds must be utilized on behalf of your child. Remember that cashing out of some assets may incur costs and tax any profit on liquidated funds.

When it comes to custodial accounts and taxes, keep in mind that any deposit above $15,000 triggers the federal gift tax. Children who file their parents’ taxes are entitled to a certain amount of dividends and capital gains taxed at a lower rate. The first capital gain of $1,050 is not subject to yearly taxation. The next $1,050 is taxed at the custodian’s rate (about 10 percent). Everything over that is subject to taxation at the parent’s rate.

Since custodial accounts are considered assets, they may jeopardize your child’s ability to get financial aid for college when it comes time to apply to a University.

How Can You Optimize Your Custodial Account?

When you open a custodial account for your child, you’ll almost certainly be dealing with stocks or stock-like funds like ETFs.

If you’re worried about your child’s money with the risk of investing in stocks and mutual funds, bear in mind that, over time, trading or investing in mutual funds has shown to be a significantly more successful way to produce interest than a simple savings account. It would help if you struck a balance between your drive to make money and your willingness to lose it. 

How Is A Custodial Account Taxed?

taxes and custodial accounts

Another significant distinction between 529 plans and custodial accounts is the tax treatment of donations.

Money invested in a defined contribution plan grows typically tax-deferred, and withdrawals are tax-free as long as the funds are utilized for eligible higher education expenses. However, contributions to custodial accounts are not tax-deductible by the IRS. 

Because UGMA and UTMA accounts are not tax-deferred assets, any gains on assets such as investment properties are taxed as ordinary income. It would be in your best interest to consult with a tax advisor for more information on tax implications.

Gift Tax Exemptions

Contributions to 529 funds and custodial account contributions are considered a financial gift to the underage recipient under the law. The Internal Revenue Service (IRS) provides guidelines for how much you may give before paying taxes on your contributions. You may give each of your children $15,000 each year without using up any of your annual gift tax exclusion if you’re a parent.

The maximum amount you may gift as a couple is $30,000. Grandparents can gift the same amount to their children and grandkids each year. Of course, you can contribute more, but doing so will deplete a portion of your lifetime gift and estate tax exemption.

Role Of The Custodian

The adult custodian is described as managing assets on behalf of another. This setup generally refers to an adult legally responsible for the account on behalf of the child, usually a parent. A child’s custodian might be their parent, guardian, step-parent, grandparents, or other relatives.

Custodial accounts are often opened to save and invest for children hoping that they will put their money to better use when they reach maturity. Once you’ve created one, you may utilize a custodial brokerage account for various financial goals, such as education savings, retirement, or general investing.

Can Money Be Withdrawn From A Custodial Account?

withdrawing money from a custodial account

A custodial account for a child teaches them how to invest and learn about financial management.

You may use this time to talk about investment options, go over account statements, and offer children a say in critical decisions impacting the account’s finances.

The custodial accounts’ requirements differ from state to state, but the account holder’s chosen individual is responsible for the account. If it is in the child’s best interests, the custodian can take money from the account. However, according to the law, custodial account funds must only benefit the minor child.

The topic of the child’s costs and the custodians comes up frequently. Consider seeking professional financial guidance on how to best use the cash in the account. Certain disbursements may be permitted by law, but the custodial account cannot be used to pay for daily expenditures that the guardian or parent is legally responsible for meeting.

Frequently Asked Questions

Is a custodial account a good idea?

A custodial account is an excellent method to provide money to a child, whether it’s yours, a relative’s, or a friend’s. An adult sets up this account to benefit a minor under UGMA or UTMA. After the account is activated, you may teach the child some fundamental investment techniques. For example, you might speak about your goals and investing options, go over account statements, and examine the account’s profits and losses.

Can you invest in stocks with a custodial account?

When the custodial account is formed and financed, the real fun begins: investing the money. Through their brokerage account, your children will be able to participate in selected securities, mutual funds, index funds, and marketplace funds. 

Several approaches may be used to get your children interested in investing, including assisting them in selecting one or two stocks, which may entail purchasing shares and building the rest of the account with equity funds.

Can a grandparent open a custodial account?

A custodial account is created and managed for a juvenile by someone over the age of 18. For example, a parent typically opens a custodial account for their child. Although, a minor’s custodial account can be opened by grandparents, other family members, or acquaintances.

What are the contribution limits for a custodial account?

Anyone can make a tax-free contribution of up to $15,000 per child each year. This sum is inflation-adjusted and may rise over time. However, a deduction cannot be obtained since the donations are made with after-tax cash.

For children under the age of 19 and full-time students under the age of 24, the first $1,100 in earnings is tax-free if less than half of their support. After that, gains ranging from $1,100 to $2,200 are taxed at the child’s tax rate. Payments over $2,200 are taxed at the estate and trust brackets tax rate. 

What is the minimum opening deposit for a custodial account?

Banks have multiple minimum account balances and interest rates. The custodial account is open to everyone. When the child achieves the age of majority, the account is transferred from the custodian to the minor. However, when the children reach maturity, they can choose when and how to use the money.


A custodial account is a financial account set up for a child by an adult. The adult who creates the account controls its management, including making investment selections and deciding how the money gained will be used as long as it benefits the child. A custodial account has certain tax benefits, but it also has concerns, such as the likelihood of the performance-limiting the amount of financial help a child will get.