What is a Custodial Account? – Defined & Explained

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I'm Donny. I'm a world traveler, investor, entrepreneur, and online marketing aficionado who has a big appetite to compete and disrupt big markets. I thrive on being able to create things that impact change, difficult challenges, and being able to add value in negative situations.

A custodial account lets you contribute to your child’s future and safeguard your investment. Here is all you need to know about this versatile financial tool.

Key Takeaways
  • The purpose of a custodial account is to allow an adult to manage the savings of a child until they reach adulthood.
  • There are no income, contribution, or withdrawal penalties.
  • A tax professional can show you how to lessen the tax burden of a custodial account through strategic contributions.
  • A child gains control of their account when they reach legal adulthood. This age varies according to their U.S. state of residence.
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Custodial Account Definition

A custodial account is a savings account that an adult opens and manages for their child. The child will have control of the funds when they reach adulthood.

Banks, brokerage firms, mutual fund companies or other financial institutions can open your custodial account.

How Does a Custodial Account Work?

Custodial accounts serve to ensure that management actions are in the account owner’s best interest. The account owner is a minor who needs approval from the custodian to make investment or withdrawal decisions.

The fiduciary who manages the custodial brokerage account must act on behalf of the account owner. They may not make investment decisions such as putting money into speculative stocks or buying futures or derivatives.

This control ensures that financial actions benefit the account holder, who gains control of the account when they reach the age of majority. A parent can use a custodial account to educate their child about investing.

Examples of Custodial Accounts

Fidelity Investments and Charles Schwab are two significant players in custodial accounts and securities management. These companies design custodial brokerage accounts to maximize tax benefits and investments while safeguarding the funds.

Types of Custodial Accounts

There are two primary types of custodial accounts:

  1. Uniform Transfers to Minors Act (UTMA): UTMA accounts are open to any type of investment, such as real estate, artwork, intellectual property, precious metals, jewels and cash assets. UTMA accounts are not legal in South Carolina and Vermont.
  2. Uniform Gift to Minors Act (UGMA): The fiduciary can contribute only cash assets to a UGMA account. This includes cash, bonds, annuities, securities, mutual funds, and insurance policies. UGMAs are legal in every state.

Benefits of Custodial Accounts

There are many benefits to a custodial account:

  • Any adult can transfer assets to a child without establishing a special trust account. The financial institution safeguards all contributions and investments until the child is an adult.
  • Custodial accounts have flexibility. The child can spend the money on a college education or other important life events such as a new home, car or their wedding.
  • The child tax rate applies to earnings up to a certain point because the Internal Revenue Service (IRS) sees the child as the owner of the custodial account. The first $1,150 of unearned income has no tax obligations.
  • There are no contribution limits. Unlike other investment vehicles, you are free to invest as much as you wish in your child’s future, and other family members or friends can also contribute to the custodial account.
  • There are no withdrawal penalties. All withdrawals must be for the benefit of the child only.
  • A custodial account is simpler and less expensive to establish than a trust fund.
  • Financial institutions manage the setup of custodial accounts with efficiency to ensure you understand the terms and conditions.
  • Including a custodial account in your estate planning can reduce estate taxes if you die before your child reaches the specified adult age.
  • The two main varieties ofcustodial accounts are UGMA and UTMA.

Drawbacks of Custodial Accounts

There are a few drawbacks to a custodial account:

  • There are fewer tax breaks in a custodial account than in other similar accounts. All investment gains on property are taxable, and gifts exceeding $15,000 per year are also taxable.
  • Contributions and gifts to the account are irrevocable. It is best to consult with a financial advisor to see what you can do to make a financial gift to the account and still qualify for federal aid to cover educational expenses.
  • A custodial account might reduce government aid, including college financial help, for the beneficiary.
  • A custodial account is not a tax shelter from the IRS or individual states because it has so few tax benefits.
  • Once you have established the account, you cannot change the beneficiary. A parent surrenders control of the funds to their child when they reach the required adult age.

How to Open a Custodial Account

Follow these five simple steps to open a custodial account:

  1. Research a brokerage firm and choose one that meets your investment objectives.
  2. Set up an account for your child or another beneficiary.
  3. Provide important details such as the child’s name, date of birth and social security number.
  4. Fund the account. You can make a one-time contribution and then invest that money into other options to grow the account.
  5. Start researching investments. Work with an investment adviser to map out a contribution plan. You should also research investment options to decide where to invest the principal amount.
Stash Custodial Account

Invest in a child’s future. Give them a head start with a custodial account from Stash. Start with $5.

We earn a commission if you open an account, at no additional cost to you.

3 Best Custodial Accounts

Here are what many consider to be the three best custodial account managers based on past performance, professionalism and security:

1. Fidelity custodial account: Fidelity Investments is the gold standard of private investing. It has over $4 trillion in assets under management, and a brokerage account with this company will give you peace of mind about your child’s future.

2. Charles Schwab One custodial account: Charles Schwab offers banking, commercial banking, investment and wealth management services.

Charles Schwab has over 29 million brokerage accounts, 2.1 million retirement plan participants, and over 1.5 million bank accounts as part of its $8.5 trillion client asset management portfolio.

3. Vanguard custodial account: Vanguard sells itself as an investment advisor and takes an active role in managing any account that a client opens.

With over $7 trillion in global asset management, this investment company will provide expert administration of custodial accounts and other investments.

Is a Custodial Account a Good Idea?

A custodial account is an investment account at a financial institution in the name of a minor. The financial institution manages the account until the minor is an adult.

The fiduciary who acts on behalf of the minor is usually a parent. Custodial accounts provide tax advantages, investment freedom and the security of knowing the investment will be there when the child is an adult.

A custodial account is a good idea for the future of your minor child, so talk to an investment advisor today.

Custodial Account FAQs

Can I withdraw money from a custodial account?

Yes, you can withdraw any amount at any point with the approval of the custodian.

What is the difference between a custodial account and a savings account?

A custodial account requires the approval of a custodian to invest or remove funds, while the account holder alone manages a savings account.

What happens to a custodial account when a child turns 18?

Once the child is an adult, they assume control of the custodial account.

Is there a limit to the amount I can deposit in a custodial account?

There is no limit to contributions to the account, although you may want to manage contributions to maximize your tax benefits.

Stash Custodial Account

Invest in a child’s future. Give them a head start with a custodial account from Stash. Start with $5.

We earn a commission if you open an account, at no additional cost to you.

I'm Donny. I'm a world traveler, investor, entrepreneur, and online marketing aficionado who has a big appetite to compete and disrupt big markets. I thrive on being able to create things that impact change, difficult challenges, and being able to add value in negative situations.

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