Many parents want to save for their child’s future. One way to do this is by setting up a custodial account. This type of account specifically allows an adult to put money into a savings or investment account for a minor, which they can then access once they reach adulthood.
Custodial accounts can be a great way to give a child a financial gift. These funds can eventually be used for such expenses as their education, a car, wedding, renting an apartment, or even buying a home. If college is a particular goal, you can even open a custodial account designed for this very purpose.
If you’re considering opening up a custodial account for a young person, read on to learn what a custodial account is, the different types, and how they operate.
What is a Custodial Account?
A custodial account is savings or an investment account, established with a bank, brokerage firm, or mutual fund company, that’s managed by an adult on behalf of a minor, also known as the beneficiary.
Custodial accounts typically allow a parent, grandparent, family friend, or guardian to start saving for the child, until they reach adulthood, which depending on the state of residence, could be 18, 21, or even 25 years of age.
Even though the custodian manages and oversees the funds, the account is in the child’s name. Once the child reaches adulthood, the account legally transfers to their control.
Recommended: What is Retail Banking?
How Custodial Accounts Work
Opening a custodial account is simple. You can likely start one with almost any financial institution, brokerage firm, or mutual fund company. All a custodian probably needs to establish one is to provide basic personal information about themselves and the child. Once a custodial account is created, the adult can start contributing funds into the account.
The financial institution sets the terms of the account, which may include a minimum balance, maintenance fees, and initial investment requirements, among other stipulations. Individuals can usually contribute as much as they want to a custodial account, but there’s a federal cap on how much you can contribute that’s free of the gift tax imposed by the IRS. In 2023, this amount is up to $17,000 for individuals and $34,000 for married couples per child, per year.
Custodial bank accounts usually come with protections for the beneficiary. While the custodian can withdraw money from the account, legally the money must only be used to benefit the minor. This means the adult in charge of the account can’t use the funds for their own personal reasons. Additionally, any contribution made becomes the property of the child, so transactions can’t be changed or reversed.
A monthly contribution to a custodial account can make a big difference in a child’s life because the money can substantially accumulate over the years. According to Fidelity Investments, starting to contribute $50 a month to a custodial account when a child is 5 years old can result in $21,000 once that child reaches age 21. Put in $150 a month and that amount goes up to $63,000, while $250 a month clocks in at $104,900.
Recommended: Tax Credits vs. Tax Deductions: What’s the Difference?
Types of Custodial Accounts
There are two main types of custodial accounts: the Uniform Gift to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). While both have the same objective and eliminate the need to start a trust, they work in slightly different ways. Another option is the Coverdell ESA and 529 accounts that can help with saving for college.
Uniform Gift to Minors Act (UGMA)
The Uniform Gift to Minors Act (UGMA), established in 1956, is a custodial account that grants adults the opportunity to give or transfer many different kinds of financial assets to a child. Here’s what is important to know:
• Besides cash, assets in an UGMA account can include individual stocks, index funds, bonds, mutual funds, and insurance policies.
• UGMA accounts aren’t limited to educational expenses. In fact, the money can be used by the beneficiary for anything once they come of age. A UGMA doesn’t have restrictions or contribution and withdrawal limits, but, as previously noted, gift tax limits apply.
• This kind of custodial account is available in all 50 states and is easy to set up at many financial institutions and brokerages nationwide. Keep in mind there may be a minimum deposit required to open an UGMA.
• There aren’t any tax benefits for contributions, but up to $1,250 of any earnings from a custodial account may be exempt from the IRS, and a portion of up to $1,250 of any earnings greater than the exempt amount may be taxed. If so, it will be at the child’s tax rate, which is generally lower than their parent’s tax rate.
• Since education costs are one main reason parents or loved ones open a custodial account, one thing to know is because the funds are considered an asset owned by the child, it can affect their ability to get financial aid and student loans.
Uniform Transfers to Minors Act (UTMA)
The Uniform Transfers to Minors Act (UTMA), is a newer, expanded version of an UGMA. There are some differences between them to be aware of:
• The main difference is that an UTMA account can include physical assets, such as cars, art, jewelry, and real estate.
• You are not able to open a UTMA in every state. Currently, South Carolina and Vermont are two that don’t allow you to open a UTMA custodial account. And many states have a higher age at which a beneficiary can take control of a UTMA compared to a UGMA account.
• The zero contribution limits, tax benefits, and financial aid impact that come with UGMAs are the same for UTMAs.
Coverdell Education Savings Account (ESA) and 529 Plans
There are two educational savings plans that fall under the umbrella of custodial accounts and can help a parent save for college for their child. One is the Coverdell Education Savings Account (ESA).
• This type of custodial account exists solely for saving for a child’s future educational needs. According to the IRS, ESA contributions made must be in cash and are not tax deductible.
• Unlike UTMAs and UGMAs, there’s a $2,000 limit per year to how much you can contribute to the ESA’s account beneficiary.
• ESA custodial accounts also have income-based restrictions and are only available to families who fall under a certain income level. Coverdell ESA’s are created by each state so you’ll need to see if your state offers one.
A 529 College Savings Plan, also known as a “qualified tuition plan” is often considered a kind of custodial account because it’s created to pay for the beneficiary’s educational expenses, whether it’s for college, tuition costs for kids in grades K-12, certain apprenticeship programs, and even to pay student loans.
• Unlike other custodial plans, a 529 College Savings account can remain in the holder’s name even when the beneficiary reaches the age of majority in their state.
• There aren’t any income limits for a 529 Plan, which differentiates it from a Coverdell ESA.
• The 529 Plans are state-sponsored and most states offer at least one. You must be a U.S. resident to open a 529 Plan.
• You don’t have to be a resident of the state and can pick another state’s plan, but your state may offer a tax deduction if you live there and open one. The Federal Reserve features a list of state 529 Plans.
Custodial Accounts vs. Traditional Savings Account
Both a custodial account and a traditional kid’s savings account can be opened with the goal of putting money away for a child’s future. However, they are two separate types of accounts that operate in different ways.
• A traditional savings account opened for a minor is a type of joint account that typically can be accessed and used by both the minor and their parent or guardian. Some states and financial institutions have age limits or restrictions on whether a child can be on a joint account. With a custodial account, as previously mentioned, a minor can’t make any transactions until they reach the age of maturity.
• Traditional savings accounts typically have no limits on how much money you can keep in the account, but banks may have a base amount you need to open an account along with minimum balance requirements.
• Custodial accounts may be better for long-term savings, while a traditional savings account can teach kids about banking and good finance habits.
Recommended: Understanding the Different Types of Bank Accounts
Pros and Cons of Custodial Accounts
Custodial accounts have their upsides and downsides. Here’s some pros and cons to consider, presented in chart form:
| Pros of Custodial Accounts | Cons of Custodial Accounts |
|---|---|
| Easy to set up | Custodian loses monetary control when beneficiary comes of age |
| Can be inexpensive to establish | May have a cap on how much you can contribute due to gift-tax laws |
| May have tax benefits | Not as tax-exempt as other types of financial accounts |
| Money is the property of the child | Can impact the ability to get financial aid |
| Anyone can make a contribution to the account | Contributions are irrevocable |
4 Steps to Opening a Custodial Account
Setting up a custodial account is simple and doesn’t take up a lot of time. Here’s how to open a custodial account in four steps.
1. Decide on the Type of Custodial Account
Research the various options to determine which kind of account would best suit your goals and those of the child. For example, is the goal strictly for educational expenses? Are there limits to contributions? Do you want contributions to include physical assets as well as monetary funds?
2. Figure out Where You Want to Open the Account
Banks, brokerage firms, and mutual fund companies all offer custodial accounts. Pick the one that best suits your comfort level, familiarity, and goals for the child.
3. Gather the Child’s Personal Information as Well as Your Own
When you open the account, you’ll want to have the necessary information ready, such as the custodian and child’s Social Security numbers, addresses, phone numbers, and dates of birth.
The person who will be controlling the account will most likely have to provide employment information and have the account number(s) ready for another bank or investment account they want linked so they can transfer the money between accounts.
4. Open the Account
Many financial institutions make it easy for you to start an account online through their websites, or you can go to the financial institution in person.
The Takeaway
Custodial accounts can be a solid way to sock money away for a child’s future, whether it be for their education, a financial gift, or to provide them with a leg up on savings once they become young adults. These accounts can be opened at financial institutions and banks around the country, and you don’t even need to leave home to set one up. Depending on which type of custodial account you choose, you may also enjoy some tax-advantages too.
FAQ
Are custodial accounts a good idea?
They can be. Saving and investing money on behalf of a child can make their lives easier once they’ve become an adult. Having a built-in financial cushion they can use for their education, housing, a trip, or even towards retirement can be a valuable gift to someone as they start their adult life.
How does a custodial account work?
A parent, grandparent, guardian, or loved one can open a custodial account for a child, at a bank, brokerage, or mutual fund firm. The account is for the benefit of the child and managed by an adult or the custodian of the account, with contributions added over time, if desired. Once the child turns 18, 21, or 25 (depending on which state they live in), the money is turned over to them.
What are the pros and cons of custodial accounts?
The advantages of a custodial account are an automatic savings available to the child when they become of age, typically to spend on whatever they want; some potential tax breaks for the person who opens the account; and the ease of setting them up. Downsides of a custodial account include a possible cap on how much you can give because of gift-tax restrictions; the inability to reverse any transaction after its completed; and, since the account is considered an asset of the child, it could affect their ability to be eligible for financial aid when applying to schools.
Photo credit: iStock/Drazen Zigic
SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2024 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.
SoFi members with direct deposit activity can earn 4.20% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.
As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.
SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.20% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.
SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.
Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.
Interest rates are variable and subject to change at any time. These rates are current as of 10/31/2024. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
This article is not intended to be legal advice. Please consult an attorney for advice.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SOBK0423034