Financial institutions offer a wide range of options for young people to get an early jump on savings or investing.
Depending on your goals, college savings plan, trust accounts, and even Roth IRAs can be highly effective for building the foundation of a child’s financial future. These accounts provide parents with specialized tools for investing on behalf of your children. A custodial account, meanwhile, is a simple and flexible way to save for a wide variety of near- and long-term goals for your kids.
What is a custodial account?1
A custodial account is an investment account established in the name of a minor by an adult custodian. This custodian makes decisions regarding the assets in the account until the child is old enough to assume full control. You might see these accounts referred to by the laws that established them—the Uniform Transfer of Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA).
When the custodian makes contributions to the account, the contributions belong fully to the child and cannot be retrieved. Otherwise, the custodian has complete control over the assets.They can determine how the money is invested and when it can be withdrawn. When the child reaches adulthood at age 18 or 21—also known as the age of majority—they take on these responsibilities for themselves.
Custodial accounts will typically be limited to a safe, low-return range of investments such as certificates of deposit or money market funds. A brokerage or mutual fund firm will grant you access to a wider variety of investment vehicles in a custodial account. These can include stocks, bonds, mutual funds and exchange-traded funds (ETFs).
State laws will vary with regard to a minor’s age of majority, the tax consequences of custodial assets and limitations on how much money you can add to an account annually, among other factors. Consult with your financial institution to familiarize yourself with these laws before opening an account. Federal tax rules, especially gift tax limitation, can come into play when you give money to your child’s account.
What are the benefits of a custodial account?
The benefits of custodial accounts are varied. First, they are easy to open. They are also flexible, and the assets can be put to any purpose that benefits the child, unlike 529 plans for example, which must be used for strictly educational purposes.
With some limitations and exceptions, gains on the assets held in custodial accounts are taxed at the child’s income level rather than the custodian’s, which can mean significant tax savings. Remember UTMAs and UGMAs vary from state to state, and you should do your homework regarding your state’s custodial tax rules.
Upon reaching the age of majority, your newly minted adult will be free to assume full control over the account and continue investing the funds or withdraw them for whatever purpose.
Are you financially ready to open a custodial account?
A crucial question to ask before making any investment is whether or not you are financially ready to do so. Just as you should ask yourself whether a particular investment suits your long-term financial plans, take the time to consider whether an irrevocable gift to a minor— a custodial account—aligns with your goals. Will such a gift hamper your ability to meet your own objectives? If so, you might not want to open one at this time.
What are your goals for the account?
If you are ready to open a custodial account, consider goals for your child and how a custodial account can achieve them. For most families, college education looms as the number one long-term financial goal. Remember that an education-specific account like a prepaid tuition or education savings plan may make sense if secondary education is your sole focus for your child.
Tuition may not be your only goal, however. A custodial account grants you and your child the freedom to use your custodial assets for a wide range of purposes, such as extracurricular sports, art classes or musical instruction. If your child needs a laptop or a guitar to pursue these interests, a custodial account is one way to save for such an expense. Just be sure to plan ahead for larger expenses such as a car or summer camp, if you want to draw from the custodial account for those big-ticket items.
How to open a custodial account
Opening a custodial account is similar to opening a standard bank or investment account. Since the minor is technically the owner of the account, you will need their social security number and other personal information. As the custodian you will receive any future communication about the account once it’s open.
When considering what type of custodial account to open, first identify your goals. Are you saving for the near-term, or for long-term goals like college or retirement? A custodial savings account makes for easier deposits and withdrawals at local bank branches, and provides easy access to funds in the short-term should you need them.2 A brokerage account can offer access to a wider range of investment opportunities to help you target long-term savings goals. But invested funds are less liquid and harder to access should you need them on short notice.
Taking advantage of a teaching opportunity
Many kids lack a basic understanding about money, how saving and investing works, and how to stick to a budget. Opening a custodial account can provide an opportunity to educate your child and lay the groundwork for achieving future goals. You can teach your child what it means to set aside a small amount of money for investments every month or year, or how to evaluate investment options and interest rates, and track the performance of those investments over time.
Teaching them the importance of compound interest and how it can boost savings over time, and demonstrating how to budget can help them achieve long-term objectives. By opening a custodial account for your child, you can take the first step toward developing that knowledge, setting them on the path to lifelong financial awareness and potential success. With Stash+($9/month), you can open two custodial accounts1 with a minimum deposit of only $1.00.3 Stash Learn can also help you teach your kids about the basics of budgeting, saving, and investing.