'Custodial Account' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
A Custodial Account refers to a particular type of savings account. These can be accessed via a mutual fund company, financial institution, or brokerage firm. With these accounts, an adult controls and manages the funds or assets on behalf of a minor who is less than 18 years old. State laws govern the rules that affect these special accounts. Minors may not perform transactions in such an account without first obtaining mandatory approval of the custodian. Such an account might also be one of the retirement accounts which a custodian handles for any and all employees in a firm who are eligible to have one of these.
With a Custodial Account, it is typically the guardian or parent of the minor in question who has oversight on the account. Such investments contained in these forms of accounts are limited to mutual funds or similar products that regulated investment companies offer their clients. Every company that administers such a Custodial Account will have its own particular rules on the interest rate levels and account balance minimums they maintain.
What is interesting is that any person is allowed to contribute into a Custodial Account. The minors will not have access to any choices made by the account or money in it without their guardian’s consent until they attain the legal age of adult hood. At this point, the ownership of the account transfers over from the custodian(s) and on to the minor. The minor would then gain full decision-making powers over how and when to utilize this money.
Two different kinds of Custodial Accounts exist in the United States. These are the UGMA Uniform Gift to Minors Act administered accounts and the UTMA Uniform Transfers to Minors Act ones. With the UGMA, parents and other are able to provide assets to their minor children in the forms of cash, savings bonds, life insurance, annuities, or stocks. The UTMA permit parents to postpone any distributions from the account. Each state has its own age limits which can be established by the parents or guardians.
There are a number of advantages to these two types of Custodial Accounts. Withdrawal penalties, contribution limits, and income restrictions do not apply to either of them. When a single contribution in excess of $14,000 goes into the account, this does become treated as a “gift,” and the IRS will naturally then levy a gift tax on the total. Custodians also have the ability to transfer the account balance over to a 529 plan. In order to do this, the custodian first will be required to close out any investments inside the account which are not cash.
There are a few disadvantages for the minors to having one of these accounts. The government and university/college systems recognize such accounts as assets. This means that they will often decrease the ability of the minor to obtain financial aid in the college or university admissions process. This is why financial planners will often suggest that such an account should not be opened for any minor who might hope to qualify to receive financial aid packages.
Taxes will also apply to withdrawals from these accounts. Every state has its own ruling on the matter regarding whether they will be taxed at the rate of the minor or the parents’ income tax bracket. Some of the unearned income becomes tax free. The rest will become fully taxable at either the child’s or guardian’s federal tax rate. There will also be capital gains taxes assessed on any earnings from liquidated assets in these Custodial Accounts.
Any gifts presented to such an account can not be rescinded later. The beneficiary of the account also can not be changed subsequently. The parents are required by law to file the child’s tax returns when they have such an account until the minor becomes old enough to transfer over the ownership of the account. Once the minor attains the age of 18, then all dividends and earnings within the account will become subject to the minor’s applicable tax rate.