how a custodial account works
once established a custodial account functions like any other account at a bank or brokerage the custodian a designated manager or investment advisor decides how to invest the money the account manager or other entities can continue to contribute to the fund as noted above custodial accounts can invest in a variety of assets however the financial institution probably won t allow the manager to use the account to trade on margin or buy futures derivatives or other highly speculative investments once the minor reaches the legal age of adulthood in their state control of the account officially transfers to the named beneficiary from the custodian at which point they claim full control and use of the funds should the minor die before reaching the age of majority the account will become part of the child s estate types of custodial accountscustodial accounts come in two basic varieties the uniform transfers to minors act utma accounts and the older uniform gift to minors act ugma accounts their main distinction lies in the kind of assets you can contribute to them there are two types of custodial accounts the uniform transfers to minors act utma and the uniform gift to minors act ugma the utma is allowed in all states except vermont and south carolina while the ugma is allowed in all 50 states utma accounts can hold virtually any kind of asset including real estate intellectual property and works of art ugma accounts are limited to financial assets of cash securities stocks bonds mutual funds annuities and insurance policies every u s state allows ugma accounts however south carolina and vermont don t allow utma accounts both utma and the older version ugma have custodial accounts set up in the minor s name with a designated custodian usually the child s parent or guardian initial investments minimum account balances and interest rates vary by the company that houses the account advantages and disadvantages of custodial accountsthere are advantages including tax advantages for custodial accounts but there are also downsides including the risk that the account will limit the amount the child can access in financial aid in college because it s considered an asset owned by the minor custodial accounts have enormous flexibility there are no income or contribution limits and no requirements to make regular distributions at any point also there are no withdrawal penalties while all withdrawn funds are restricted to being used for the benefit of the minor this requirement is vague and isn t limited to educational costs as with college savings plans the custodian may use the funds for everything from providing a place to live to paying for clothing as long as the beneficiary receives a benefit a custodial account is much simpler and less expensive to establish than a trust fund the aim of both ugma and utma regulations was to allow adults to transfer assets to minors without the need to establish a special trust to enable such ownership while not tax deferred like iras custodial accounts have some tax advantages known as the kiddie tax the irs considers the minor child the owner of the account so the earnings are taxed at the child s tax rate up to a certain point every child under 19 years old 24 for full time students who files as part of their parent s tax return is allowed a certain amount of unearned income at a reduced tax rate for 2024 the first 1 300 of unearned income is tax free the next 1 300 is subject to the child s tax rate then anything over that amount may be subject to the parent s tax rate however once the minor reaches the age of majority in their state of residence they can file a tax return at this age all account earnings will be subject to the beneficiary s tax bracket at the filing age also an individual can contribute up to 18 000 for the 2024 tax year without incurring the federal gift tax a minor s ownership of the custodial account can be a double edged sword because the holdings count as assets they may reduce a child s financial aid eligibility when they apply for college it could also reduce their ability to access other forms of government or community aid any deposit or gifts made to the account are irrevocable meaning they can t be changed or reversed all the account s holdings pass irrevocably to the minor at the age of majority in contrast many college savings plans such as a 529 account allow parents to retain control of the funds custodial accounts aren t as tax sheltered as other accounts to mitigate a tax bite a custodian can transfer education funds to an eligible 529 plan however to do so the custodian must liquidate any non cash investments in the custodial account also the custodial account beneficiary can t be altered whereas the beneficiary on a 529 college plan may change with some limitations a custodial account is set up in the minor s name because the account is irrevocable the beneficiary of the account may not change and no gifts or contributions made into the account can be reversed easy to establish and managefree from income contribution or withdrawal limitscan invest in a variety of assetsless tax advantaged than other accountscan hurt child s financial aid prospectsirrevocably passes to child upon majorityexamples of a custodial accountmost brokerages both digital and brick and mortar offer custodial accounts custodial account terms usually parallel those of their regular non tax advantaged accounts for individuals for example a merrill edge the digital broker platform from merrill lynch ugma utma custodial account can be set up online with funds directly transferred from a checking or savings account at bank of america merrill s parent company there are no annual account fees or minimum investment amounts you can also open custodial deposit and checking accounts at most bank branches can you withdraw money from a custodial account yes money can be withdrawn from custodial accounts as long as it is used for the benefit of the minor a vague term that includes but isn t limited to educational costs 