There are times where you may want to help a child to start saving up for the future, saving for college or help to teach them how to manage money. Depending on your exact goals there are different ways to go about doing this, but one option is to set up a custodial savings account.
The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) have provisions to allow an adult to set up a custodial account for a minor, whether for one of their children or not, and maintain control over the account until the child reaches the age of majority.
So what are some things that you need to know when setting up a custodial savings account? What are some of the pros and cons?
Custodial Savings Accounts – What Are They?
A custodial savings account is an an account setup at a bank that is controlled by an adult for a minor child. Depending on what state you're living in the actual definition of a minor can vary since the “age of majority” will be different depending on the state. In some states you become an adult at the age of 18, others the age is 21.
With a custodial account of just about any type the adult will control the account until the minor reaches adulthood, at which time the account legally becomes theirs and they can do with it as they see fit.
Under most custodial accounts the minor may not make changes to the account or do engage in any transactions without the consent or approval of the adult custodian.
In most cases the custodian of an account is going to be the parents of the minor, but usually any legal adult could be a custodian of an account for a minor. So in some cases that could mean a grandparent could have a custodial account for a grandchild,etc.
Opening A Custodial Savings Account
Setting up a custodial account is pretty easy. Let's look at one example through a company I work with called CIT Bank, the process will be similar for most other banks.
CIT has a custodial savings account that you can setup through their site here. Basically when opening the account you'll just choose that you want to open a custodial account when choosing what type of account to open.
Once you choose that you want to open a custodial account the bank will ask you what type of account you want to open. There are a variety of custodial accounts available, but at CIT Bank there are either CD accounts or Savings accounts. You can also open custodial accounts for mutual funds, brokerages and more at other companies.
Once you choose that you want to open a custodial savings, it will ask for your personal information as well as information about the minor, including Social Security numbers (so have them handy). Once you're done the account will be confirmed and setup.
In short, setting up a custodial account is as simple as signing up for just about any other checking or savings account. It will just be governed by slightly different rules once it is setup.
Pros Of Custodial Savings Accounts
There are a lot of reasons why people open and contribute to custodial savings accounts.
First, a lot of people like the fact that you can make unlimited contributions to a custodial account, unlike some other account types like a 529 college savings plan.
Second, there are no income restrictions on custodial accounts so anyone from any income bracket can give money to one of these accounts.
Third, custodial accounts are a good way to avoid the estate tax by giving the money as a gift while still living. For people who want to avoid the estate and gift taxes, you can give up to $14,000 every year ($28,000 per couple) and put it into the custodial account.
Custodial savings accounts can be a good way to give a small financial gift, especially if you want to give the child a taste of ownership in an account of some time, to help instill some good financial principals. As long as the income generated from the account is small enough, below $950, there is no tax on the account.
Cons of Custodial Savings Accounts
When you're setting up a custodial savings account there are a few downsides to be aware of.
First, when you setup the custodial account the money is no longer technically yours. The money is now the child's money, and from then on that money can only be used for purposes that benefit them. You can't re-purpose the money and claim it as yours again.
Second, the child will gain complete control over the money when they reach adulthood. Even if the child isn't ready for the money – if they aren't mature enough or financially savvy enough – they will still have control over the money when they reach the age of majority.
Third, the child might need to file taxes if they make enough income. If the income from the accounts exceeds $950, a separate income tax return will need to be filed for the child at their tax rate. If above $1900 in gains are made, the money can be taxed at the parent's higher rate.
Fourth, if you give more than $14,000, or $28,000 as a couple, to your child's custodial account, you'll be liable for gift taxes on that money. Be aware of that and be careful not to go over if you don't have to.
Finally, there are consequences for your child's financial aid when they decide to go to college if they have custodial accounts in their name.
Custodial savings accounts aren't for everyone, or for every situation. For example, if you're looking to save for a child's college education there might be some other plans more suited to the goal like a 529 plan, ESA or a Roth IRA.
If, however, you'd like to make a small gift to a child or family member it might be a good option. As long as you're only giving $13,000 or less per year to the account, you can avoid gift taxes. It can also be a good way to avoid estate taxes down the line if you're looking to leave money to loved ones.
Custodial accounts can also be a good teaching tool, a way to teach your child about managing money, and the power of compound interest.
Do you have a custodial account? What are your thoughts on this account type and how it fits into your financial plans?