Custodial accounts

Custodial accounts are opened for minors under the age of 18. A custodian must open the account and manage the assets on behalf of the minor, but the assets in the account are the property of the minor. Custodians are typically parents, but technically can be anyone. Only one custodian and minor are allowed per custodial account.

If you want to open a custodial account for a child, all you need is their social security number (SSN), as all of the taxes are reported under the minor’s SSN. Reporting taxes under the minor’s SSN is a big benefit. Minors typically pay little or no taxes due to their lack of reportable income.

The two types of custodial accounts are UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfer to Minors Act), named after the laws that created them. The UGMA was the first version of a custodial account, which requires custodians to give control of the assets to the minor at the age of majority (usually 18 or 21 depending on the state). UTMAs were created later and allow custodians to delay the transfer of assets (up to the age of 25 depending on the state).

A custodial account is a type of fiduciary account. Fiduciaries must put the interests of the account owner before their own. Therefore, custodians invest with the minor’s best interest in mind and disregard any activities that would only benefit themselves.

In addition to acting in their best interest, custodians cannot pursue risky investment strategies in UGMA or UTMA accounts. Short sales, margin, and some option strategies are examples of prohibited activities in fiduciary accounts.

All gifts made to a minor’s custodial account are irrevocable, and cannot be taken back. The custodian may only take withdrawals to spend money on items that will directly benefit the child*, or they may keep the assets in the account until they must be turned over at adulthood. Additionally, the assets in a custodial account can never be transferred to another beneficiary. Bottom line - as soon as the account receives a contribution, it’s the minor’s money!

*Withdrawals from custodial accounts may not be used for essential living expenses, which include food, clothing, and shelter. However, they may be spent on non-essential items that will directly benefit the child, including the cost of summer camp, a computer, a car, education expenses, etc.