A custodial brokerage account is an account opened by an adult, or custodian, in the name of a minor under the age of majority. Once opened, the custodian is responsible for managing the account by contributing or buying assets and securities for the minor.
A custodial brokerage account functions similarly to other taxable brokerage accounts, with a few key differences.
The custodian—such as a parent, guardian, grandparent, or family friend—opens the account in the minor’s name. Then, they contribute money to buy assets like stocks, bonds, and mutual funds. Once the minor reaches the legal age of majority (18 to 21, depending on the state), the account transfers into the beneficiary’s control.
One crucial component of custodial accounts is known as “fiduciary responsibility.” Essentially, a fiduciary must act in the best interests of a beneficiary—in this case, the minor child. While the custodian maintains control, they must contribute, invest and spend funds in ways that benefit the account owner.
Custodial brokerage accounts come in two varieties:
Brokerages typically offer at least one, with account minimums and interest rates varying between institutions.
UGMA accounts were established under the Uniform Gift to Minors Act. These accounts can hold financial assets like cash, stocks, bonds, funds, and insurance products. All U.S. states permit UGMA accounts.
UTMA accounts are a newer flavor established under the Uniform Transfers to Minors Act. These accounts can hold almost any asset, including securities, real estate, artwork, and even intellectual property. South Carolina is the only state that doesn’t permit UTMA accounts.
Custodial accounts carry plenty of flexibility, including no income or contribution limits, distribution requirements, or withdrawal penalties. Individuals can contribute up to $15,000 per year ($30,000 for joint filers) per custodial account without triggering the federal gift requirement.
Custodial accounts also come with some small tax advantages. Because the account owner is technically the minor, initial earnings are taxed at the child’s tax rate. Children under 19 (24 for full-time students) who file taxes with their parents:
Once the minor reaches the age of majority, they then assume control of the account and pay taxes in their own bracket.
Custodial brokerage accounts do carry some disadvantages.
To start, the account beneficiary can’t be altered once established, even to transfer assets to another minor. Additionally, contributions are irrevocable, which means the custodian can’t take back gifted funds. (If a custodian does withdraw funds, the money must be used for the minor’s benefit.)
And because the minor is the legal owner, custodial accounts may reduce the child’s eligibility for educational, government or community aid down the line.
Custodial accounts let parents, guardians, or other persons help minors get ahead in life. While there are advantages to consider, they also come with unusual risks, including throwing up barriers to necessary financial aid before they reach the age of majority.
As such, before you open a custodial account, it’s crucial to weigh the downsides against prospective benefits for the child’s future.
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