- Custodial accounts help adults save and invest money on behalf of a minor—until the minor reaches a certain age when the account must be transferred to them.
- Money put into a custodial account is an irrevocable gift to the minor named as beneficiary on the account—the custodian must ensure that it is invested or used for the minor's benefit.
- Between the age of 18 and 25 (it varies by state) legal control of the account must be turned over to the beneficiary, who can then use the money for any purpose they choose.
Looking for a convenient way to manage a child's money until they grow up? Whether the money comes from gifts, an inheritance, or earnings, a custodial account is one way to save and invest for a minor. Money put into these types of accounts becomes the property of the minor and can only be used for their benefit. The state legislation that allows for gifts to minors is the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act (UGMA/UTMA). One or both of those acronyms are often associated with custodial accounts.
The major advantage of custodial accounts is that they make it easy to give financial gifts to a child. The second related benefit is that you don't have to set up a trust to do it—which can be costly.
Custodial accounts can have some drawbacks though. UGMA/UTMA brokerage accounts are considered assets owned by the child, which can impact financial aid when applying to college. Also, no matter what kind of custodial account, the custodian must transfer the account to the beneficiary at a relatively young age (between 18 and 25) and the money can be used for any purpose.
How custodial accounts work
Here are the logistical details: The adult custodian opens the account for a specific beneficiary. The adult can then add money to the account and choose investments. When the child reaches the age of majority specified by the state, control of the account must be transferred to them. The age of majority varies by state but is generally between 18 and 25. In some cases, it's called the age of trust termination.
At some financial institutions, like Fidelity, the account may be restricted if the beneficiary passes the age of majority and control has not been transferred. Though it is a mandatory process, it has to be initiated by the custodian. If the account was restricted because of a delay in transferring control, any restrictions would be lifted once ownership was transferred.
At Fidelity, you can change your account registration online once the minor has turned 18 or reached the age of majority.
Of course, custodial accounts are not the only way to manage money for a child—a trust could also be established which may allow for more control over when the beneficiary can access the money and how it can be used.
Read Viewpoints on Fidelity.com: Do you need a trust?
There are several types of custodial accounts.
- A Roth IRA for Kids allows an adult to save a minor's earned money in a retirement account that lets earnings grow tax-free as long as the money stays in the account. If the money is withdrawn before age 59½ without qualifying for an exception, there may be taxes and penalties due.
Like all custodial accounts, the minor will take control of the account when they reach the specified age in their state.
Learn more by reading: Turbocharge your child's retirement with a Roth IRA for Kids
- A custodial 529 account is very similar to a traditional 529 account. The key difference is that the beneficiary on a custodial account cannot be changed. There may be tax advantages when money in a 529 account is used for qualified educational expenses but there may be taxes and penalties due if the money is used for other purposes. For financial aid purposes, custodial 529 accounts are considered parent-owned assets, and have a minimal impact on financial aid calculations.
Read Viewpoints on Fidelity.com: The ABCs of 529 savings plans
- The Coverdell ESA is also a custodial education savings account. They have a $2,000 annual contribution limit. There is also an income cap which can limit who can contribute to one of these accounts.
- UGMA/UTMA brokerage accounts are taxable investment accounts with no contribution limits. These accounts offer no tax benefits at the time the contribution is made and realized earnings like interest and dividends are taxable. At Fidelity, the UGMA/UTMA brokerage account offers comprehensive trading and a wide range of investments, including stocks, bonds, mutual funds, exchange-traded funds, options, CDs, and more.
UGMA/UTMA brokerage account considerations
UGMA/UTMA brokerage accounts can make sense when saving and investing on behalf of a minor, but there are some important things to know about the accounts.
Money put into a custodial account belongs to the beneficiary—it's called an irrevocable gift. At the age of majority, the custodian (often a parent) must transfer control to the beneficiary. At that point, they can do whatever they want with the money.
The gift tax may be a consideration
There's no limit to the amount you can put into an UGMA/UTMA. But gifts to an individual above $15,000 a year typically require a form to be completed for the IRS. Also, any amount in excess of $15,000 in a year must be counted toward the individual's lifetime gift-tax exclusion limits (the federal lifetime limit is $11.58 million per individual in 2020).
Realized earnings are taxable
Earnings are subject to taxes. Income from investments is considered unearned income by the IRS. For children, unearned income above $2,200 is taxed at the rates used for estates and trusts. If interest and dividend income comes to less than $11,000, the parent can include that income on their return.
Little control over how the money is used
Once the assets are transferred, the beneficiary can use them for any purpose. Each state has different rules for determining the age of termination when the beneficiary should take control of the account.
Financial aid may be impacted
Financial aid can be adversely affected by custodial accounts. They are considered assets owned by the child.
Learn more on Fidelity.com: Financial aid planning
Is a custodial account right for me?
When choosing an account, it's important to consider your goals and needs as well as that of the child or teenager. There are situations where a custodial account makes a lot of sense and could make planning easier. For instance, if your child inherits or is gifted money, you could use a custodial account to manage the money until they grow up and can manage it on their own. For people who need more control over the money, a preferable alternative could be setting up a trust.
On the other hand, if you are a parent saving your own money for a child's education, a 529 account may make more sense than a custodial 529 or an UGMA/UTMA. That's because 529 accounts offer a greater degree of flexibility and control, as well as tax benefits.
It may be a good idea to check with your attorney or tax advisor to help choose the best option for your situation. Before opening a custodial account, evaluate your goals, those of the beneficiary, and take stock of all your options to make sure that it's the right type of account for you.