A custody account is a financial account that parents manage on behalf of their child – a tool for transferring and building wealth that can invest in almost any asset.
custody accountis an investment account in the name of a minor child managed by an adult.
- Custodial accounts are cheaper, easier to manage, and less constrained than trusts or specialized education accounts.
- A custody account passes irrevocably to the child when he reaches adulthood.
Many parents are obsessed with building a nest egg for the next generation. A key tool in the accumulation and preservation of wealth can be summed up in two quick words: custody account.
A custody account is simply an investment account in the name of a child but managed by an adult. It offers much more flexibility than other traditional child-focused savings and investing options (think 529 education savings plans and accounts). Like a trust, another must-have generational transfer vehicle, it keeps control in the hands of a parent, grandparent, or guardian, but it’s much cheaper and easier to create.
Custody accounts come with caveats – the main one being that the child takes charge of the account when they become a legal adult, which means having control of a potentially large amount at a fairly young age (18 or 21).
Here’s everything you need to know about custody accounts.
What is a deposit account?
Strictly speaking, any account opened and operated in a person’s name by another responsible party – a trustee, required to act in the best interests of the account holder – can be considered a custodian account.
Quick fact: 401 (k) plans are technically custodial accounts, with the employer and the plan administrator acting as custodians of the employees.
But most people use the term to refer to a financial account that an adult controls for a minor, usually a child or grandchild. This adult acts as account keeper – hence the name “custody account” – for the minor, who is the beneficiary and the technical holder of the account.
Child custody accounts come in two forms. The main difference is in the types of assets that each can hold.
- Uniform Law on Gifts to Minors (UGMA) Accounts can hold most types of financial assets, including cash, stocks, bonds, annuities, and insurance policies. But they are limited to this liquidity. All 50 US states allow UGMA accounts.
- Uniform law on transfers to minors (UTMA) accounts can contain any type of asset. This includes alternative investments like real estate, intellectual property, works of art and collectibles. South Carolina is the only state that does not allow UTMA accounts.
Take note: Although often grouped together, a custody account is not quite the same as a guardian account. Owners / beneficiaries of guardian accounts may include minors but are also often adults unable to manage their money due to mental or physical disabilities. Creating a guardian account requires a court order containing specific instructions regarding the management of the account and its funds.
How to open a custody account
Parents, grandparents and guardians can open custody accounts at banks, credit unions, brokers and financial services companies – both of the traditional brick and mortar type, like Vanguard, Fidelity and Charles Schwab, or online platforms / applications, such as Etrade, Acorns and TD Ameritrade.
These financial institutions set the terms of the accounts: initial investment requirements, minimum account balances, interest rates, management fees. Usually these terms are pretty much the same as any regular business account.
Anyone – parents, relatives, friends – can put any amount of money into a custody account. Due to donation laws, many cap contributions at $ 15,000 ($ 30,000 for married couples) per child per year.
Whatever the amount, contributions to the securities account are irrevocable. Once the money is deposited into a deposit account, it cannot be recovered. Even if the child dies before reaching legal adulthood, the account is paid as part of the child’s estate.
Quick advice: Custodial accounts are typically brokerage accounts or regular bank accounts, funded with after-tax dollars. You
can create a custody account as a traditional or Roth IRA. But then the contributions will be limited to the amount of earned income that a child earns each year.
Benefits of deposit accounts
Compared to other savings and investment options, deposit accounts offer a number of advantages, including:
- Efficiency: Custodial accounts are easy to set up – much easier and cheaper to set up than, say, trusts (another common way to transfer funds and save money on behalf of a minor).
- Flexibility: There is no limit on income or contribution to deposit accounts and no penalties for early withdrawals or restrictions on the use of funds, as is the case with Education Savings Accounts (ESA). and plans 529.
- Estate planning: Because it is an irrevocable gift, the money or assets placed in a deposit account effectively leave the contributor’s estate, which can reduce their income or estate taxes. Since the legal owner of a custody account is a minor, the income from the account is reported as the minor’s income. Under IRS rules, a minor’s income is taxed at a lower rate than adults (up to a certain amount – $ 2,200 in 2021).
- Variety: Deposit accounts can trade or hold any asset or investment offered through the financial institution. The only exception: due to their fiduciary responsibility, many institutions will not let these accounts hold more speculative investments, such as futures or derivatives. Margin trading (borrowing money to buy stocks) is also generally excluded.
Disadvantages of custody accounts
While there are many advantages to custody accounts, some of the disadvantages are also worth remembering. These include:
- Financial aid: Custody accounts are considered the property and assets of the child. Minors with substantial means are quickly eliminated from the list of students who will benefit from financial aid. Say goodbye to the prospect of low cost student grants and loans.
- Lack of tax breaks: While deposit accounts include tax benefits, they exclude other tax benefits as well. Contributions to deposit accounts are not accompanied by deductions when filing taxes. When a child in the custody account becomes an adult, they will also owe taxes on any gains made on the account at their usual tax rate.
- Irrevocable: A custody account legally belongs to its beneficiary – the child. Once they reach legal age, they have full control over it and can use the product however they want – regardless of the parents’ intention.
The financial report
Savvy seniors see custody accounts as a cost-effective, streamlined way to start building a nest egg for a child.
A custody account, which is equivalent to an investment account controlled by an adult in the name of a child, offers much more flexibility than other savings and investment accounts, such as ESAs.
Any amount of money can be placed in a custody account, transferred from an adult’s accounts (and out of their estate). As easy to open as any bank or brokerage account, custody plans offer a cost-effective alternative to the costly and time-consuming process of establishing a trust.
But contributions to the deposit account, like the account itself, are irrevocable. While parents enjoy almost unlimited management for years, the account ends up being under the control of the child, at the legal age of adulthood in their state.
So use the custody account not only to build wealth for your children, but also to teach them some financial responsibility.