Rules Related To Opening Custodial Accounts
A custodial account is held with an adult as the custodian, but in the eyes of the law, the assets in the account belong to the child and are held in his name. The child, however, canât get his hands on the accountâs assets until he reaches his majority â 18 years old in some states and 21 in others.
The custodian who establishes the account â typically a parent, grandparent or other relative â has management responsibility over the account. In other words, the custodian must be involved in all decisions to buy or sell securities or reinvest earnings generated by the account, even though the investments in the account belong to the minor. The beauty of establishing a custodial account is that part of the earnings and gains in the account are taxed at a low rate on the average.
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Financial Accounts You Can Open For Your Child
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With the rising student and housing debt and an overall lack of retirement savings, helping children get on the path to greater financial literacy and security is a priority for many people. Parents, relatives, and friends can help a child by contributing to their financial future with a custodial account. The Uniform Gifts to Minors Act or Uniform Transfer to Minors Act are the two main types of custodial accounts used to give financial gifts to minors. The benefactor manages the irrevocable gift until the minor becomes of age, from 18 to 25, as determined by the state. The investments within the account are taxed at the minors rate and subject to the kiddie tax.
UGMA and UTMA arent the only options when choosing a child’s financial account. Alternatives to custodial accounts include 529 college savings accounts, trusts, and Coverdell Education Accounts. Each of these account types have advantages and disadvantages. Its important to understand how the funds within each account are taxed as well as how they may impact the childs eligibility for higher education financial aid, if helping with higher education is the intention of the account.
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Factors To Consider When Choosing A Custodial Account
Now that you know the difference between UGMA/UTMA accounts and why going with a major broker is best, here are a few more factors to consider when picking a custodial account.
- Fees: The best custodial accounts don’t charge monthly fees or commissions for stock and ETF trading.
- Account Minimums: Most brokers have $0 funding requirements for custodial accounts, but watch for any minimum requirements, especially for robo-advisor type services.
- Available Assets: What assets do you plan on investing in? Outline this information first so you know if brokers with no-transaction-fee mutual funds or more ETF options are worth it to you or not.
- Other Features: Other features like child savings accounts, robo-advisors, access to human advisors, or various banking features can make one custodial account provider superior to others.
How Custodial Accounts Work
Here are the logistical details: The adult custodian opens the account for a specific child. The adult can then add money to the account and choose investments. When the child reaches a certain age , assets and control of the account must be transferred to them.
At some financial institutions, like Fidelity, the account will be restricted once the child passes the state-mandated age and control has not been transferred. Though it is a mandatory process, it has to be initiated by the custodian. If the account was restricted because of a delay in transferring control, any restrictions would be lifted once ownership was transferred.
At Fidelity, you can change your account registration online once the child has turned 18 or reached the age mandated by the state. Custodians will be notified when this process needs to be initiated.
Of course, custodial accounts are not the only way to manage money for a childa trust could also be established which may allow for more control over when the child can access the money and how it can be used.
Read Viewpoints on Fidelity.com: Do you need a trust?
There are several other types of custodial accounts.
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Vanguard 529 College Savings Plan
Low-Cost Investment Account for Future Education Expenses
The Vanguard 529 College Savings Plan is a Nevada 529 plan available to families in all 50 states.
Although the Vanguard 529 College Savings Plan is unlike many 529 plans in that it doesnt offer a special state income tax deduction for in-state families chiefly because Nevada doesnt have a state income tax it does offer a key tax advantage common to all 529 plans: namely, investment income that grows tax-free.
No matter where you live or plan to send your kid to college, you never have to worry about paying state or federal income tax on qualifying withdrawals from this account.
Tax benefits arent the only selling points of the Vanguard 529 plan. With generous lifetime contribution limits and the low investment fees Vanguard investors expect from the money management giant, this product is appropriate for anyone who doesnt want to pay more than they should to build an education nest egg for their kids.
Best Custodial Accounts For Kids
Clearly, custodial accounts have an important role to play in financial education. But theyre not nearly as common as noncustodial accounts.
Two federal laws, the Uniform Gifts to Minors Act and Uniform Transfers to Minors Act , make it easy for parents to set up and fund custodial bank and investment accounts for a minor child without establishing a trust .
So how do you know youre choosing the best custodial account for your child? Easy just find it on this list.
The best custodial bank accounts and investment accounts are UTMA or UGMA accounts that have few or no account fees, no fees for everyday transactions , and built-in financial education tools that teach valuable and hopefully durable lessons about managing and growing money.
When the minor account holder reaches the age of majority, many of these accounts can be converted to noncustodial status, giving the beneficiary full control of the account.
Most of the custodial accounts on this list also pair with noncustodial accounts that adults can use like any other. That makes the financial education process worthwhile for the whole family.
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How Do I Open A Custodial Account
Custodial accounts are typically easy to open, especially if you’re using an online-based broker like those on our favorites list. You’ll have to fill in a few pages with information about yourself and the account’s beneficiary, as well as some information about investment goals and other topics.
As a tip, be sure to track down identifying information for the account beneficiary before you start.
Two Types Of Custodial Accounts
When choosing to set up a custodial account, there are 2 main types to choose from: a Uniform Transfers to Minors Act account or and the older version, a Uniform Gift to Minors Act account.
Both types of accounts are set up in the minor beneficiarys name along with the custodians name. This can be a parent, grandparent, or legal guardian. The accounts are very similar in how they work, but they differ in what types of assets they can hold.
A UTMA account can hold just about any type of asset, including cash, real estate, artwork, and intellectual property, such as patents, copyrights, trade secrets, and trademarks. Whereas UGMA accounts are limited to assets only financial in nature, such as cash, stocks, bonds, mutual funds, and insurance policies.
Both accounts are valid in nearly all states in the U.S.
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Do Custodial Accounts Get Taxed
Custodial accounts do get taxed. However, a benefit of the UGMA and UTMA custodial account is that when you invest money on a childs behalf, the income gets taxed to the child rather than the custodian. Since most children have little or no income, they can get taxed at a lower rate than their parents. Unearned income from $0 to $1,100 is tax-free if the child has earned no income. Unearned income above $2,200 is taxed at the parent’s marginal tax rate if the child has no earned income.
Choose The Right Broker
No matter which type of brokerage account you decide to open for your kids, you’ll need to start by finding a broker that offers custodial accounts. The best investment accounts for kids charge no account fees, and have no minimum initial deposit. This gives your kids the chance to start investing with a small amount of money.
Consider, too, the costs associated with the investments your child plans to choose. For example, for kids who want to practice trading stocks, you should ensure the broker charges low or no trade commissions. If your kids just want their money to grow in a hands-off way, consider looking for brokers with a large selection of low-cost index funds.
If youre looking for a brokerage account to teach your kids about investing, know that many brokers offer educational content, including online investing tutorials and even practice trading accounts.
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Show Them How To Save
Saving is a concept you can introduce to children from a young age, even before specifically applying it to money. For example, think about any rewards systems you have in place for your child. You can demonstrate what it means to save up their points, tokens, toys, etc., by setting achievable goals. Budgets are another concept you can introduce fairly early on as they begin to grasp what saving means. As your children get older, you can show them how to save their allowance or paychecks from a part-time job to purchase items they want. This can be done through a joint checking account or financial planning app.
Ugma And Utma Accounts
There are two types of custodial accounts: the UGMA and the UTMA .
These two types of accounts are very similar in nearly all respects. The most significant difference between the two is the date at which control of the account passes to the child. A custodian loses control over an UGMA account once the child reaches his majority â 18 or 21, depending upon the state. By contrast, a custodian is permitted to postpone transfer of control of an UTMA account to a child, depending upon the state, until 25.
Whether you establish an UTMA or an UGMA account, these accounts have very strict rules that prevent custodians from using them as their personal piggybanks. Furthermore, while you can withdraw money from the account for your childâs benefit, the assets in an UGMA account canât be used to pay for things that you are legally obligated to provide to support your child . However, UTMA accounts are more liberal than UGMAs in that they permit funds in the account to be spent for the support of the child.
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Custodial Accounts Vs Trusts
Typically, a custodial account is much simpler to use than a trust. A trust tends to be more expensive because of additional fees and legal expenses and is more time-consuming. Trusts are similar to custodial funds because they offer legal protection for the assets involved as well as possible tax benefits.
Trusts differ from custodial accounts because a trust has the option to stipulate how the assets can be used. Even though the assets belong to the beneficiary, trusts can specify guidelines on how the assets can and are intended to be used. While a trust can be beneficial if there is a larger sum of money involved, a custodial account is likely a more accessible alternative for relatively smaller amounts of funds.
What Is The Difference Between A Trust And Custodial Account
The differences between a trust and custodial account are twofold: the level of simplicity for establishing a custodial account as compared to a trust and the greater flexibility and control that comes with a trust.
To learn more about trusts and how they might benefit your situation, consider visiting Trust & Will. They assist with making estate plans and trusts easy as well as making sure everyone in your family is covered.
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What Is A Custodial Brokerage Account
This type of account lets an adult, such as a parent, grandparent, or family friend invest money on behalf of the child. This means that while the child owns the assets contained in the account, the adult makes all of the investment decisions.
Todays brokerage platforms help adults invest on behalf of the minor and build a diverse portfolio in a wide array of assets, including a combination of stocks, mutual funds, bonds and ETFs.
Keep in mind that all assets in a custodial account are considered irrevocable gifts and are held in the childs name. You will not have the power to change the child who benefits from the account once it is set up.
The account must be transferred to the minor when he or she reaches age 18 or 21. Depending on the state you live in, this age can be up to 25.
Your goal is most likely to provide financing for college tuition or other higher education costs. But keep in mind that once this account is transferred, the young adult can use the money in any way they choose, such as a new car or home.
At that point, youve relinquished control of investing decisions.
Investing For Kids: The Best Investment Accounts To Open Early
What is one thing you wish you learned in school growing up? For many people, the answer includes how to file taxes, buy a house, or manage money effectively. While these are crucial life skills, many individuals are left to teach themselves how to handle them. However, it does not have to be this way for the next generation.
With the right financial education, children can develop a strong sense of financial security and money management. Thats why investing for kids is such an important topic to share with your little ones. Keep reading to learn about the best ways to talk to kids about money and investing.
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Best Custodial Accounts Of September 2022
The best custodial accounts offer features that matter most to kid and adult account owners: low fees, investment education and strong customer support.
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The investing information provided on this page is for educational purposes only. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.
Looking for a way to set your kid up with an investment account, but aren’t sure where to start? Custodial accounts are a common way for adults to start an investment account for a child or grandchild, then hand the account off to them when they’re legally an adult themselves. You may also see custodial accounts described as UGMA/UTMA accounts. This is based on the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act the legislature that allowed for the formation of these accounts.
Best For All Types Of Investors: Charles Schwab
Why Charles Schwab made our list:
Known as the Schwab One Custodial Account, this account offers investors several perks. These include a $0 minimum opening deposit, $0 account setup and maintenance fees, and commission-free stocks and ETFs. In addition, you can invest in mutual funds and other securities and utilize investment research and other tools.
With Schwab Stock Slices, you can invest in fractional shares as long as you meet the $5 minimum requirement. And as with all custodial accounts, won’t have to worry about any contribution limits. Parents and guardians might also consider Schwab’s custodial IRAs , 529 college savings plans, and education savings account .
Another advantage of Schwab’s custodial account is that it isn’t just for self-directed investors. You can automate your investments by setting up the account through the Schwab Intelligent Portfolios or Schwab Intelligent Portfolios Premium robo-advisors. Just note that you’ll need a minimum of $5,000 for the former and at least $25,000 for the latter.
Once the account beneficiary reaches legal age, they’ll retain complete ownership of the account’s earnings and can then utilize additional Schwab products if so desired.
What to look out for: If you decide to take the automated investing route for your custodial account, you’ll need at least $5,000 for Schwab Intelligent Portfolios and $25,000 for Schwab Intelligent Portfolios Premium.
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Potential Drawbacks Of Custodial Accounts
Now, there is no such thing as a perfect type of financial account for everyone, and UGMA/UTMA accounts are no exception. Here are few potential drawbacks to using a custodial account to gift money or assets:
- Custodial accounts are irrevocable. If you put $100,000 into an UGMA and later change your mind for whatever reason, you can’t just take it back.
- Aside from being taxed at the child’s tax rate, there are no special tax advantages. At least not in the direct sense that accounts like IRAs and 529 Savings Plans have.
- Custody of the account ends when the beneficiary is 18 or 21 . For obvious reasons, 18-year-olds having sudden access to a large sum of money can be a less-than-ideal situation.
- Since the assets in a custodial account technically belong to the minor, it can adversely affect their ability to qualify for financial aid in college.