Custodial Accounts

Description

Custodial accounts are designed for an adult to make an irrevocable gift to a minor in the form of cash or gifts.  Once a person has transferred an asset to a minor, the minor actually owns the asset and the person who transferred the asset has no access or authority over the funds at this point.  A custodian is a person who manages the assets for the minor until he or she reaches the age of termination.  Custodial accounts are governed by laws which were adopted by each state. 

Because legal or tax issues may be involved with a custodial account, we suggest consulting a tax or legal adviser before opening this type of account to determine what would be appropriate for your individual needs.

Objective 

While not only intended to pay for educational expenses for a child, a custodial account is a way for parents, grandparents, guardians, friends and family members to transfer assets to a minor.  The use of a custodial account is often times preferable when dealing with small sums of money and generally don't require the services of an attorney. 

Tax Features

The child owns the account and is liable for any income generated by the account assets.  Since the child owes the tax, payment from the account to pay the taxes generated by the account is considered payment for the benefit of the child.  Please consult a tax attorney for the taxing of custodial accounts.

Withdrawals

Withdrawals may be initiated by the custodian for the benefit of the child.  They are not limited to college expenses.

Problems with custodial accounts

A very large UGMA or UTMA account may diminish your child's chances of receiving financial aid.  If this is a concern, you may want to consider opening a 529 Plan or an Educational Savings Account instead.

Custodial Account Eligibility Requirements

The minor must have a Social Security number or an individual taxpayer ID number.  Additionally, the custodian must be 18 years old or older.  If the custodian works for a broker-dealer, or is a director or significant shareholder of a publicly traded company, then additional requirements may apply.

Other useful information

Is a custodial account right for you?  Here are a few things to consider:

Problems with Custodial Accounts

There are many potential drawbacks to opening a custodial account for a minor:

1) You can't take it back.  Once you have transferred assets into a minor's account you can't take them back.  At this point they belong to the minor.  Even if the child wanted to give the assets back they probably couldn't due to the fact that the child is not old enough to give valid consent in such matters.

2) Financial Aid.  Many people think that a custodial account is a great way to save for college and later find out that the account causes a reduction in financial aid available to the child.  Please weigh this possibility if the chance of reduced financial aid is a concern.  Many times the financial aid is in the form of student loans, so less student loans means less debt.

3) If you have more than one child you cannot transfer funds from one account to another.  While not necessarily a negative, if a parent sets up a custodial account for one child and the account does well and is unable to contribute to the second child later, that could cause a dilemma for the parent.

4) Depending on the state, when your child turns from 18-21 (depending on your state), the custodian must turn over the assets to the child.  At that point the child can spend the money any way they wish.  How will you feel if they spend it all on a trip or a new car?

5) Estate tax issues.  If the custodian dies before the account terminates it will be included in your estate.  Consult a tax professional for estate tax and all tax issues.

6) Income tax issues.  As a parent, you have a legal obligation to support your child.  If the IRS deems that you used income in the custodial account to satisfy that obligation the income may be taxed to you and not the child.  Be sure to know the laws in your state.

  

                     

Custodial accounts are just one of many options available and one should consider all of their objectives.  Other options include a Coverdell account, a 529 plan, a traditional or Roth IRA, setting up a trust, etc.  Please make sure to consider the best possible plan for your circumstance.  There are other factors involved in setting up a custodial account.  Please consult your tax and financial expert for further explanation.

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