Is a custodial account the same as a savings account?
The term custodial account generally refers to a savings account at a financial institution, mutual fund company, or brokerage firm that an adult controls for a minor (a person under the age of 18 or 21 years, depending on the laws of the state of residence).
Regulated banks like JP Morgan are a good place for companies to hold their operating cash (up to the FDIC insured amount), make payments, and manage their day-to-day financial needs. Custodians, on the other hand, are financial institutions that provide safekeeping and asset servicing for their clients.
However, custodial accounts are commonly thought of in one sense: an account controlled by an adult for the benefit of a minor, typically a family member. Custodial accounts allow adults to give minors cash, securities, real estate, annuities, insurance policies and other assets more easily than setting up a trust.
The drawbacks: You can't change the beneficiary of a custodial account once it's established. Your child can use the money however they want after reaching a certain age, and investment income in custodial accounts may trigger the kiddie tax. The account can impact financial aid eligibility.
Upon the beneficiary's reaching the age of majority, the custodian has a duty to turn the account over to the beneficiary, at which time the beneficiary will become the account owner with complete authority over the account.
A portion (up to $1,250 in 2024) of any earnings from a custodial account may be exempt from federal income tax, and a portion (up to $1,250 in 2024) of any earnings in excess of the exempt amount may be taxed at the child's tax rate, which is generally lower than the parent's tax rate.
Gifts are irrevocable: Contributions to a custodial account are considered irrevocable—meaning you can't get that money back—and funds can be withdrawn by the custodian only to pay for expenses that would directly benefit the child before the age of majority.
Assets held in a child's name, as in a custodial account, weigh more heavily against financial aid eligibility than do the parents' assets or assets held in a 529 account or an education savings account (ESA). In addition, a custodial account doesn't have the same tax advantages as a 529 or an ESA.
A custodial account is generally created by a parent or grandparent for the benefit of a minor child or grandchild. When you put money into a custodial account, you make a gift to the minor beneficiary of the account, even though the minor does not control the account.
Understanding What a Custodial Account Is
In most cases, it's a brokerage account or savings account that an adult controls for a child under the age of 18. Once the child is of age, he or she assumes ownership and can control the account how he or she wishes.
What happens if you withdraw from a custodial account?
Withdrawals: Withdrawals from custodial accounts must be used for the benefit of the minor. Once the minor reaches the age of majority, they can use the money for any purpose without any restrictions. 5. Contribution limits: Custodial accounts have contribution limits, which vary depending on the type of account.
Otherwise known as an UGMA/UTMA account, there are no income or contribution limits—and no early-withdrawal penalties or restrictions on how the funds are used for the child.
There are two main types of custodial accounts: the Uniform Gift to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). The largest difference between the UGMA and UTMA is that the UTMA covers more assets. For instance, with a UGMA account, you can include assets such as stock, bonds, and mutual funds.
A custodial account can be an effective savings tool, but it's important to understand its pros and cons. Your advisor can help you determine which tool or combination of tools are right for you given your financial circ*mstances and investment goals.
How Do Taxes Work with a Custodial Account? The child beneficiary technically owns the custodial account — not the custodian. It's the beneficiary's Social Security number that is attached to the account. Thus, the child is the one who technically needs to pay taxes.
Do I Have to Pay Taxes on My Child's Savings Account? Interest earned on a savings account is considered unearned income. Per IRS rules, if a child has more than $2,500 of unearned income, that money will be taxed at their parents' tax rate or their own—whichever is higher.
No matter how old you are, your parents will have full access to your funds as long as they are joint owners of your account. They will not need your permission to dip into your account, and while it is hard to imagine your parent taking your hard-earned money, or money set aside for tuition, it happens.
Any income from a child's custodial account belongs to the child. If that income exceeds certain thresholds, you'll need to file a separate federal income tax return for the child using Form 1040, 1040A, or 1040EZ.
The IRS knows who the custodial parent is because the parent is obligated to tell them when they file a tax return. The person who signs at the bottom of the return attests that all of the information is compete and accurate.
- Greater impact on financial aid. Because they're held in the name of the child, UTMA/UGMA accounts hurt financial aid eligibility more than comparable 529 plans.
- Money becomes the child's at majority. ...
- Transfers are irrevocable.
Do custodial accounts expire?
Under the laws that govern custodial accounts, including the Uniform Transfers to Minors Act (UTMA), account custodianship ends and the beneficiary becomes eligible to assume control of the account at a specified age—typically 18 or 21, depending on the state.
TO WHOSE ESTATE DOES THE CUSTODIAL ACCOUNT BELONG? Custodial accounts are part of the minor's estate in the event of the minor's or custodian's death prior to the minor attaining distribution age unless you, as the donor who established the custodial account, are also the custodian.
Custodial accounts may be subject to garnishment from creditors looking to collect a debt owed. For creditors looking to collect on a debt owed by the custodian of the account, the Custodial account does not offer any special protection.
529 Plan. The primary benefit of 529 accounts is that they often offer tax advantages when used for your child's educational expenses. Unlike 529 plans, custodial brokerage accounts are generally offered by financial companies (investment brokerages) & come with few limitations.
| Custodial Account | Investing Strategy | Fees |
|---|---|---|
| Schwab One Custodial Account | Self-directed investors | None |
| Vanguard Custodial Account | Self-directed investors | None |
| M1 Plus Custodial Account | Hands-off investors | $125/year |
| Acorns Early Custodial Account | Hands-off investors | $9/month |
