Custodial accounts

Custodial account is a money term you need to understand. Here’s what it means.

What are custodial accounts?

Custodial accounts are accounts set up by parents or guardians for the benefit of minors under the age of 18. The funds in the account are considered to be an irrevocable gift to the minor, who upon attaining the age of 18 or 21 gains full control over the assets in the custodial account. An adult is appointed as the custodian of a custodial account until the minor reaches the appropriate age.

Deeper definition

Because custodial accounts represent an irrevocable gift to the child, the assets in the accounts are not considered to be part of the parents’ assets. Any income in the custodial funds are considered to be unearned income accruing to the minor. The first $1,050 of a child’s investment income is tax free, the next $1,050 is taxed at the child’s rate. Anything above $2,100 is taxed at the parent’s marginal rate of tax.

Custodial accounts are governed by the Uniform Gifts to Minors Act (UMGA) and the Uniform Transfers to Minor’s Act (UTMA).

Assets owned in a custodial account may include stocks, bonds and mutual funds but not riskier investments such as options or margins. Once set up, the beneficiary of a custodial account cannot be changed.

Although custodial accounts are usually used to provide for the child’s education, the assets in the custodial account can be used for the benefit of the child and do not need to be reserved for educational purposes. Withdrawals may be made from the fund at any stage and spent on the child for any reason. Custodial accounts may be used to help the child buy a car or home, as well as for education expenses.

Custodial account example

Jim and Mary have two young children. They realize that college education is becoming expensive, and they want to set up some form of savings account to fund their children’s education. Because Jim never went to college, he knows there’s no guarantee their children will want a college education, so he and Mary decide to set up UMGA custodial accounts that give their children the flexibility to decide how they use the money when they turn 18.

Are you uncertain which is the best way to save for your children’s education? Learn more about college saving plans.

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