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Jan 26, 2018

What’s a Custodial Account? Two Things to Know

By Lindsay VanSomeren

You can set up an investment account for a child you love. We explain how.

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Attention grandparents, godparents, aunts, and uncles. Want to contribute to a child’s financial future? You can do it with a custodial account and you don’t have to be a parent to open one.

A custodial account can be a great way to help a child you love get a financial headstart when they become adults.

But you can open one for any child you love, not just your own kids.

What’s a custodial account, anyway? Here’s the scoop:

What’s a custodial account?

They’re essentially brokerage accounts that let you put money away for a child, and then invest that cash in stocks, bonds, mutual funds and other securities.

You can keep putting money into the account until they become adults.

Learn more: How a Custodial Account Can Teach a Child About Investing

You can open a custodial account for someone else’s child

If you’re a doting grandparent, a fun uncle, a cool aunt, or any other awesome human being, you can open an account for your favorite child, according to the the Financial Industry Regulatory Authority (FINRA).

In this case, you’re considered the donor of the account. When filling out the forms to open an account, you can also specify someone else–typically a parent–to be the actual custodian in charge of the account.

Custodial accounts can be a great way to help a child you love get a financial head start

Make sure you designate a responsible adult to be the custodian, as the account is for the child’s exclusive benefit.

It’s probably also a good idea to let the custodian (usually Mom or Dad) know what you’re planning to do so they’re not totally surprised, and are prepared to take on the responsibilities.

Custodial accounts can also provide spending flexibility

While 529 plans and Coverdell accounts–two other types of savings accounts for children–are for covering education-related costs only, custodial accounts can give your children more flexibility in choosing how to spend their money once they become adults.

Once they reach their majority, they can spend the money how they wish. The age of majority typically ranges from 18 to 21, depending on state law. But it can, for example, extend to age 25 in California and Ohio.

That means your child can use it to fund the purchase of a home, start a business, pay off their college loans, or anything they want.

It’s also a double-edged sword, however: if your child wants to withdraw all that cash and use it to pay for pizza and beer, they are legally entitled to do so.

Taxes and other things to keep in mind

Annual contributions to a custodial account are not tax-deferred as they are with 529s and retirement accounts such as a traditional IRAs. Please consult a tax professional to further discuss the most ideal approach for your personal tax situation.

The first $1,050 of income, or capital gains, from the account is not taxed annually. After that, it’s taxed at the child’s rate, generally between 10% and 15%, per the most recent tax guidelines. Any amount over $2,100 may be taxed at the custodian’s higher individual income tax rate, according to the IRS.

A custodial account counts as an asset for the beneficiary, so it can affect the ability of your child to get financial aid, potentially reducing the amount of assistance they receive.

Like any investment account that holds stocks, bonds, mutual funds and other securities, the value can rise and fall depending on market conditions.

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Written by

Lindsay VanSomeren


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