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Custodial Account

A custodial account is a savings or investment account opened by an adult (the custodian) on behalf of a minor child. The child is the beneficial owner; the custodian manages and invests the funds until the child reaches the age of majority (18 or 21, depending on state and account type).

For UGMA and UTMA account specifics, see UGMA/UTMA; for education-specific accounts, see 529 plan and Coverdell ESA.

How it works

An adult (parent, grandparent, guardian) opens a custodial account for a child. The adult (custodian) puts money into the account. The child is the beneficial owner. The custodian invests the funds, makes decisions, and manages the account until the child reaches age of majority (18 or 21, depending on state and account type).

At the transfer age, the account automatically becomes the child’s to manage. The custodian no longer has control.

UGMA vs. UTMA

The two main types of custodial accounts are:

UGMA (Uniform Gifts to Minors Act). The original model. At age of majority (18 in most states), the account transfers to the child. Simple and straightforward.

UTMA (Uniform Transfers to Minors Act). A newer model allowing more types of assets and delaying transfer until age 21 (if the account-holder chooses). More flexible but subject to state law.

Most states allow both; some allow only UTMA. See UGMA/UTMA for specifics.

Investment and growth

The custodian controls how the account is invested. Options include:

Long-term growth is typical: many custodial accounts are opened at birth or in early childhood, giving 18+ years for compound interest.

Tax treatment

Custodial accounts have a special “kiddie tax” rule:

  • First $1,300 of unearned income (2024): Tax-free.
  • Next $1,300: Taxed at the child’s rate (typically 10%).
  • Excess over $2,600: Taxed at the parent’s marginal rate (preventing high-earner parents from sheltering income in children’s accounts).

This rule applies to unearned income (interest, dividends, capital gains). Earned income (from a job) is taxed at the child’s rate regardless of amount.

Example: a custodial account earns $3,500 in dividends. $1,300 is tax-free, $1,300 is taxed at the child’s rate ($130 tax), and $900 is taxed at the parent’s rate ($216 tax at 24%).

No contribution limit, but gift tax applies

You can contribute any amount to a custodial account, but gifts over $18,000 per year (2024) to any one person are subject to gift tax (unless you are married and the other spouse joins, doubling the limit). This is rarely an issue for typical families, but high-net-worth individuals should be aware.

Irrevocable

A critical feature: once you contribute to a custodial account, it is irrevocable. You cannot take the money back. You also cannot dictate how the child uses the money after transfer — if the child wants to spend it on a car instead of college, they can.

If flexibility is important, a 529 plan (for education) or parent-controlled investment account (the funds are yours, not the child’s) are alternatives.

Impact on financial aid

Custodial accounts in the child’s name have a significant impact on financial aid calculations (assessed at roughly 20% for dependent students). If substantial need-based aid is expected, this is a downside. 529 plans in the parent’s name have much lower impact.

Common uses

  • Grandparent gifts. Grandparents often open custodial accounts as gifts for grandchildren.
  • Birthday/holiday money. Consolidating cash gifts into a custodial account instead of letting children spend it.
  • Education savings. When a 529 plan is not used, custodial accounts are an alternative.
  • Long-term saving. Opening at birth, contributing small amounts, and letting it grow for 18+ years.

Upon transfer at age of majority

When the child reaches the transfer age, the account is legally theirs. Some custodians encourage the child to leave the money invested; others help the child make a decision. The custodian has no further control.

See also

Wider context