Many parents obsess over creating a nest egg for the future generation. A custodial account is one essential tool for accumulating and keeping wealth.
An investment account that is in a child’s name but is run by an adult is known as a custodial account. Compared to other conventional child-oriented savings and investing alternatives, it provides a great deal more freedom. It maintains control in the hands of a parent, grandparent, or guardian, similar to a trust, another popular generational transfer vehicle, but it is far less expensive and simpler to set up.
In a broader sense, a custodial account can refer to any fund maintained by a fiduciary on behalf of a subscriber, like the employer-based pension plan administered by the plan administrator for an eligible employee.
Types of custodial accounts for children:
UGMAs (Uniform Gifts to Minors Act) and UTMAs (Uniform Transfer to Minors Act) are two forms of custodial accounts for kids.
Parents and grandparents can deposit an unlimited amount of money into a child’s account with a UTMA, but the money must be used for the child’s benefit. Similar principles apply to UGMA accounts. However, the latter can only hold financial assets, including investments.
UTMAs can hold almost any kind of asset, including real estate, but the money must be utilized for the child’s benefit in any scenario, and it is typically impossible to take it back afterward.
Although saving money for children is a concern for both custody accounts and kids’ savings accounts, the objectives and workings of the two accounts are extremely dissimilar.
A parent will often manage the various investing alternatives in a custodial bank account. Usually, both parents and kids handle funds in a kid’s savings account.
Custodial accounts have a number of benefits over other types of savings and investing, including:
Flexibility
Custodial accounts provide you with a lot of latitude. There are no yearly income or contribution caps, and you are not obligated to make monthly payments at any point in time. Additionally, there are no fees related to withdrawals.
Efficiency
Setting up custodial accounts is simple and less expensive than, say, setting up trusts, which is another popular method for moving money and setting up savings accounts in a minor’s name.
Estate planning
Because money or assets placed in a custodial account are irrevocable gifts, they essentially leave the contributor’s estate, which can reduce income or estate taxes. Earnings from a custodial account are recorded as the minor’s income because the account’s lawful owner is a minor. In accordance with IRS regulations, a minor’s income is taxed at a lesser rate than that of adults (up to a cap – $2,200 in 2021).
Variety
The financial institution’s assets and investments may be traded or held in custodial accounts. The one caveat is that many institutions won’t allow these accounts to hold more speculative investments, such as futures or derivatives, due to their fiduciary duty. Borrowing money to buy stocks on margin is typically prohibited as well.