If you’re a parent, guardian or otherwise have a child you care about in your life, you might wonder what you can do to help them thrive once they’re on their own in this expensive world. One way to give them a head start is by investing money for them while they're young through a custodial account.
AD
Vanguard
The 529 Plan: For wherever learning leads
Benefit from low costs while you help grow your funds tax-free, backed by decades of Vanguard expertise and investor support you can count on.
What is a custodial account?
A custodial account is an investment account that's set up for a minor but managed by an adult until the child reaches the age of majority. This age varies by state but is generally 18 to 21.
Once the minor reaches the age of majority, they inherit control of the account and the funds. Depending on the account type, there may be restrictions on how the money can be spent.
» MORE: Other ways to invest for kids
Types of custodial accounts
Many custodial accounts are known as Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) accounts. Both types are taxable brokerage accounts — the main difference is that UGMA accounts allow adults to give minors cash or securities, while UTMA accounts are broader, also allowing for transfers of real estate, art and other assets not permitted in a UGMA account.
There are also many other types of custodial accounts, including retirement accounts and tax-advantaged education accounts. If you're saving for someone with a disability, you may be interested in an ABLE account.
Custodial account rules
Custodial accounts are generally governed by gift tax rules. This means if you contribute over the annual gift tax limit for the year, you may need to file a gift tax return with the IRS. But that doesn't mean you'll pay taxes on your contributions. Due to the high lifetime gift tax exclusion, most people avoid paying gift tax.
Depending on the account type, there may be other rules. For instance, 529s have limitations on what the money in the account can be used for, and custodial Roth IRAs have limitations on when earnings can be withdrawn. On the other hand, UTMAs and UGMAs are more flexible.
To learn more about the specific rules that accompany each type of account, read our related articles:
How to open a custodial account
If you've opened an investment account with an online broker before, the process of opening a custodial account is very similar. Once you've chosen a broker, you'll need to fill out an application with some personal information and then fund the account before you can get started investing. The main difference between setting up a custodial account and a general brokerage account is that you'll need the child's personal information (such as their date of birth and Social Security number), too.
» Read our picks: The best custodial accounts
Custodial accounts and financial aid
If you’re considering opening a UTMA or UGMA account to help pay for a child’s education, you should know that it may affect their financial aid eligibility. UTMA and UGMA accounts are considered assets that belong to the minor and thus may negatively impact FAFSA financial aid eligibility.
Custodial 529 plans have more favorable FAFSA treatment, as they’re considered assets belonging to the parent. That means they will only reduce the child’s financial aid eligibility by a maximum of 5.64% of the account balance.
» Need some expert help? Learn how to choose a financial advisor
