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What Is a Custodial Account?

A custodial account is created to invest in stocks, bonds, mutual funds, and other securities for a minor (a person under 18 or 21 years of age depending on their state of residence). It is a great way to make a financial gift to a child of any age. Most commonly people utilize custodial accounts for their own children, but you have the option of creating one for your relative’s and/or friend’s children as well.

Once you open the custodial account, you can provide guidance and education to the minor child that helps their future. You can work with the child on setting goals and selecting future investments while you help them build wealth with compound interest.

How Does a Custodial Account Work?

A custodial account is a type of investment account that is managed by an adult for the benefit of a minor child. When you open a custodial account for a minor child, you agree to invest and spend money with the best interest of the child in mind. As a custodian, you have full access and authority to manage the assets within the account.

Once you have established a custodial account, it then functions as any other brokerage account or bank. You, as the custodian, can utilize the funds within the account to invest in securities that benefit the minor child. When that child becomes a legal adult, the custodianship ends. The formerly child, now adult, will have full control over the account.

Example of a Custodial Account

If you are a parent and want to save for your children’s future, you can open a custodial account. When you set up a custodial account, you are setting up a type of savings account for their future. The account funds can be used for anything in the child’s future.

It is not tied directly to their education (like a tax-advantaged 529 account would be) or have other restrictions or stipulations. Instead, the child can determine how to utilize their assets once they reach legal age, providing them with flexibility when they hit adulthood.

What Are the Tax Benefits of a Custodial Account?

There are a few tax benefits that come with a custodial account. The first is that an individual or married couple (filing jointly) can contribute $15,000 or $30,000, respectively, to a custodial account without incurring the federal gift tax.

The next benefit is that the IRS considers the “owner” of these accounts to be the child. Each child that files as part of their parents’ return is allowed a certain amount of “unearned income”. There is a tax-free portion of unearned income equal or lesser than $1,050. If an additional $1,050 is invested, it is taxed under the child’s bracket of 10%. Finally, any income exceeding $2,100 will be taxed based on the parent’s tax rate.

When Can I Make Withdrawals?

Custodial accounts have a lot of flexibility when it comes to withdrawals. In fact, there are no withdrawal penalties as long as the funds are being used for the benefit of the minor child. That means that the custodian can withdraw funds for anything from clothing to educational costs, if it benefits the child.

Is a Custodial Account a Good Idea?

A custodial account is a good idea to teach your minor child(ren) about the value of money and the concept of investing. Children continually learn as they grow, and there is no better time to educate them about their future wealth than when they are young. Not only can a custodial account help educate the child, it also helps provide them with a huge leg up for their financial future.

What Happens to a Custodial Account When a Child Turns 18?

Depending on the state in which you reside, a minor becomes an adult at either 18 or 21. When the minor reaches adulthood, they receive control of the account automatically. The account immediately transfers from the control of the custodian to the named beneficiary (the formerly minor child).

Types of Custodial Accounts

There are two different types of custodial accounts that you can select for your child: Uniform Transfers to Minors Act (UTMA) accounts and Uniform Gift to Minors Act (UGMA) accounts. The biggest difference between the two involves the assets that each can hold.

Uniform Transfers to Minors Act (UTMA)

This type of account can hold any type of asset. Not only does this include financial assets (stocks, bonds, and the like), but it also includes alternative investments including real estate, artwork, collectibles, and intellectual property. UTMA accounts are available in all states except South Carolina.

Uniform Gift to Minors Act (UGMA) accounts.

This type of account can hold most financial assets. This includes things like stocks, bonds, annuities, insurance policies, and even cash. However, they are limited to only liquid assets. UGMA accounts are available nationally.

Pros and Cons of Custodial Accounts

Custodial accounts are filled with benefits that can help you and your child save and invest in their future. However, while plenty of upsides exist, you should always understand there are downsides to consider as well before investing.

Pros of Custodial Accounts

These types of accounts are super flexible, easy to establish and offer a wide range of investment options.

Flexibility

Custodial accounts are extremely flexible. There are no contribution or income limits. And, as aforementioned, there are no withdrawal penalties.

Easy to Establish

Another great benefit is that custodial accounts are easier to establish, with less expenses than a trust fund.

Variety of Investments

You can also invest in a variety of investment vehicles on the minor’s behalf. Depending upon the type of account you choose, it can hold any asset or any financial asset.

Cons of Custodial Accounts

The pros may outweigh the cons for these types of investment accounts. It depends on the end goal however. Let’s review the downsides.

Financial Aid

When the minor child reaches adulthood, the account is considered their assets and property. That means the child could no longer be eligible for financial aid and grants.

Irrevocable

No matter what you wish for the minor child’s future, once they legally become an adult they receive full control over their assets. As a custodian, you have no say over how they utilize the account.

Minimal Tax Breaks

As mentioned above, there are a few tax breaks associated with custodial accounts. However, these accounts are not as tax-sheltered as some additional investment options.

5 Best Places to Open a Custodial Account

To open a custodial account for your child(ren), you should first do research to make sure you’re selecting the plan that best fits your ideal goals. There are many options to choose from, including the ones outlined below.

Fidelity

As one of the top brokerage accounts for retirement, the same features make Fidelity a great pick for a custodial account. 

Most Appealing Feature: Research

Fidelity provides extensive research that allows you to select the best investment choices. They provide analysis and reports on the biggest stock and fund options.

Pros of Fidelity 

Depending on your state of residency, Fidelity does not charge any fees. This includes maintenance fees, annual fees, low-balance fees, or inactivity fees. It also does not require a deposit to open the account, although you will want to put funds in it to take advantage of these benefits. 

Cons of Fidelity

There is not a lot to dislike when it comes to Fidelity. The biggest complaint is that the account verification is sometimes slow, but with all these benefits it’s worth a bit of a wait.

Best For: Research and Analysis

The resources provided by Fidelity cannot be beat. 

E*Trade

As the oldest online brokerage, E*Trade should be a contender for your child’s custodial account.

Most Appealing Feature: Longevity

E*Trade has established itself as a leader by standing the test of time as an online brokerage. It is a great option for investors who are newer to investing. 

Pros of E*Trade

E*Trade custodial accounts are ideal for beginning investors. It has easy to use tools and an extensive investment selection. 

Cons of E*Trade

Unfortunately, E*Trade has higher fees associated with the account. While there are no opening costs, there are standard trading fees that apply.

Best For: Longest Online Brokerage

The reputation E*Trade has established creates value. It has easy account set up, and plenty of research after years operating online.

Charles Schwab

Beginning investors to more established investors can all see the perks of utilizing Charles Schwab to open a custodial account.

Most Appealing Feature: One-stop-shop

Schwab provides an array of investing options. Its custodial account has the same benefits as its Schwab One investment account. 

Pros of Charles Schwab

Where to begin? Schwab is one of the best choices. It’s easy to open accounts, wide range of investment options, no monthly fees, and no minimum opening balance are just the start of why you should consider Schwab.

It has a wealth of research for you to utilize. And, if you currently have an existing account, you can use the same login for the custodial account.

Cons of Charles Schwab

We only have great things to say about Schwab. It is a fantastic option that provides you with a wide range of investment options. 

Best For: Overall Benefits

Investing with Charles Schwab is quick, easy, and filled with benefits. It is a great option for a custodial account. 

TD Ameritrade

TD Ameritrade has three different college savings options, one which is a custodial account.

Most Appealing Feature: Focus on Future Education

While the custodial account does not have to be utilized for future college education, TD Ameritrade markets their accounts with that focus in mind.

Pros of TD Ameritrade

The biggest draw to TD Ameritrade is its powerful, active trading platform Thinkorswim. This high-tech trading platform looks similar to what Wall Street traders utilize and has many advanced trading options.

Cons of TD Ameritrade

This account is not the cheapest option on the market. Trades are $6.95 each, which makes them a discount brokerage, but not the cheapest option. 

Best For: College Savings

TD Ameritrade’s custodial accounts are categorized as educational savings accounts. Although you are not required to use the funds for future savings, they do market with that goal in mind. 

Ally Bank

Ally Bank is a different type of account. Unlike traditional custodial accounts, Ally provides a more conservative approach. 

Most Appealing Feature: Interest Rates

If you are looking to create a savings account for your child(ren), Ally has the best interest rate options available. The account would be in cash, not in securities.

Pros of Ally Bank

The bank account at Ally is FDIC insured, has ATM reimbursement, and is easily managed online. 

Cons of Ally Bank

With Ally Bank, it is just a bank account. That means that while you earn interest, you do not receive any substantial returns. It is the most conservative option.

Best For: Bank Account Only

If you wish to not risk your initial capital, putting cash into a custodial bank account at Ally is a great option.

Invest In Your Children’s Future

Custodial accounts are a fantastic way for savvy investors to help their children build a nest egg. To set up a custodial account for your children’s financial future, you should work with your financial advisor.

They will provide you with options that you can research to determine which account is the most appealing. They will help you understand the types of investments involved and what kind of fees are associated with each account.