Parents hold their kids’ chubby fingers when they take their first toddle across the living room. They cheer them on when they safely learn to ride their bike down the street.
Well, saving and investing should be no different.
Luckily, there’s a type of investing account that comes with training wheels. Custodial brokerage accounts can be an excellent way to help financially prepare children for the future. They can start kids off with a nice nest egg and teach them how investments work.
You might be sold on the idea of custodial accounts but unsure about the specifics of how they work and wonder how hard it is to open one. Good news! Nearly anyone can open a custodial account, and it’s simple.
Before I jump into exactly how to open a custodial account, let’s go over how these accounts work. Additionally, I’ll fill you in on custodial account taxes, alternatives to custodial accounts, how to choose an account, and more.
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Best Custodial Accounts—Top Picks
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Robo-Advisor Micro-Investing App
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Best Self-Directed Robo-Advisor
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3.6
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4.3
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Acorns Premium: $12/mo. subscription required for custodial account.
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Free for account balances >$10k, otherwise $3/mo.
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What Is a Custodial Account?
To save for their kids, some folks just open a traditional brokerage account in their own name and informally earmark that money for their children “someday.” Others go a different route, opting for custodial accounts instead.
A custodial brokerage account involves an adult custodian and a beneficiary. Often, the custodian is a parent or guardian, and the beneficiary is a minor. The account is managed by the custodian, but the money and other assets legally belong to the beneficiary.
Custodial accounts are classified as Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts (more on this later).
A custodial account differs from a traditional brokerage account in a few ways. With a traditional account, the adult can choose if and when to gift the money to the child, whereas the assets in a custodial account belong to the beneficiary (child) right off the bat; if the custodian withdraws funds from the account, those funds must be used for the benefit of the child; and the account transfers to the beneficiary once they become an adult.
Traditional brokerage accounts offer no tax benefits because all unearned income is taxed at the adult’s tax rate. Taxation of custodial accounts is a little bit more advantageous than that (but we’ll delve into the nitty-gritty later).
Finally, custodial accounts are sometimes confused with trusts. Trusts require the help of an attorney and are usually far more complex than custodial accounts.
Related: 12 Best Long-Term Stocks to Buy and Hold Forever
Who Is a Custodian?
In the context of a custodial bank account or brokerage account, the custodian is the person who manages assets for the beneficiary. Frequently, the custodian is a parent or other relative in charge of a child’s account. More than one custodian can manage a custodial account.
The custodian opens the account, then makes investment decisions they believe are in the beneficiary’s best interests. (In some situations, a custodian might involve the beneficiary by asking their thoughts on investment decisions, but ultimately, the custodian must make the final decision.)
The custodian loses control of the account once a minor reaches the age of majority, which is 18 in most states.
Related: The 9 Best ETFs for Beginners
Can I Set Up a Custodial Account for My Child?
Yes. Parents, guardians, or even grandparents and other relatives can set up custodial accounts for the important children in their lives. Three things to be aware of before you do:
- Any contribution to the account is considered an irrevocable gift—it can’t be reversed.
- Contributions are covered by the gift tax exclusion up to the annual and lifetime limits, but they are not tax-deductible.
- Any money withdrawn from the account while the custodian controls the account must be used in a way that benefits the child.
- You cannot change the beneficiary of an account.
In short: Don’t put a chunk of change into your child’s custodial account unless you’re prepared for it to be theirs, now and forever.
Related: Roth IRA vs. 529 Plan: Which Is Better For College Savings?
Is It Smart to Open a Custodial Account?
Yes, in many situations, opening a custodial brokerage account is a wonderful way to invest in a child’s financial future. The money can be invested and start growing while the child is young. By the time the minor reaches the age of majority (more on that in a moment), the assets may have grown substantially due to the power of compounding.
However, if the purpose of the account is mainly to save for higher education, think twice before going with a custodial account. Other options have a less detrimental effect on financial aid.
Related: 529 Qualified Expenses: How to Spend Your Education Savings
Important Traits of Custodial Accounts
Here are some of the most important things to know about custodial accounts:
Assets Belong to the Minor
When an adult opens a custodial account for a minor, the minor becomes the beneficiary. While the custodian is in charge of managing the assets, including making investment choices, the assets legally belong to the minor—and any withdrawals the custodian makes must be for the minor’s benefit.
This means contributing to a custodial account is an excellent way to gift directly to the child.
The Account Is Transferred to the Beneficiary at the Age of Majority (Between 18-25)
The “age of majority” for termination of custodial accounts varies by state and by account type (UGMA or UTMA). The age is typically either 18 or 21, though in Alabama and Nebraska, the age is 19 for UGMA accounts.
Also, in a handful of states, the UTMA account termination can be delayed as late as age 25 if the account owner specifies at the time the account is established.
Once the minor reaches the age of majority, the account transfers to the beneficiary. At that point, not only do they still own the assets in the account, but they gain the power to make all investment decisions and withdraw money as they please.
The Account Is Funded With After-Tax Money
Custodial brokerage accounts are funded with after-tax money. Contributions to custodial accounts aren’t tax-deductible. And growth in the account is not tax-deferred.
It is possible to enjoy tax breaks by setting up a custodial IRA or custodial Roth IRA, but that would limit contributions to the amount of taxable income the child earns each year.
Accounts (Usually) Provide Access to a Wide Variety of Investment Options
Custodial accounts are a type of investment account, meaning the money can be invested. That means money stashed in these accounts can outperform any money put into a standard savings account.
Exactly what you can invest in depends on your account. A few custodial account providers intentionally offer a limited number of investments—say, a handful of exchange-traded funds—to prevent account holders from suffering from analysis paralysis. However, many custodial brokerage accounts act just like regular brokerage accounts, providing access to thousands of stocks, ETFs, mutual funds, bonds, and other investments.
While the custodian is responsible for all account transactions, as children get older, they can certainly discuss purchases together. Letting the child see the investment process and provide input can be a wonderful way to teach investing skills. Indeed, the custodian might let the beneficiary pick out some kid-friendly stocks from their favorite companies, such as Hasbro or Walt Disney.
Assets Are Factored Into Financial Aid Eligibility
We all know that college is expensive, and saving for it is important. However, if your plans for college include some financial aid, be careful. High-value custodial accounts can affect how much financial aid a student is eligible to receive. If you’re specifically saving money for college expenses, it’s better to create a 529 plan or a Coverdell Education Savings Account (ESA).
Because account assets in a custodial account legally belong to the child, they may reduce financial aid eligibility. Federal financial aid formulas consider 20% of the child’s money available to pay for college. Meanwhile, 529 savings plans and ESAs are considered the parents’ assets, meaning they have far less of an impact on aid eligibility—just 5.64%.
Of course, if you expect to pay for the beneficiary’s college expenses in full, this isn’t an issue.
Related: The 13 Best Investment Apps for Beginners
How to Open a Custodial Account for Your Child
Opening custodial accounts is relatively simple. Just follow the steps below:
1. Do Your Due Diligence in Choosing an Account Provider
The provider you pick will be a partner in helping you save for your child’s future, so choose one offering the features that are a good fit for your needs.
To help evaluate possible providers, do some research in the following areas:
- Costs: Costs for a custodial account vary, so make sure to compare prices before opening an account. Consider both monthly fees and any transaction fees.
- Investment selection: The brokerage account you’re considering may offer a vast variety of investment options or it may just provide a few simple options. Stocks, ETFs, and mutual funds are popular choices.
- Mobile app + desktop portal: Providers with both a user-friendly mobile app and desktop portal make it much easier to conduct transactions and monitor investments.
- Educational content: A child’s financial future isn’t just dependent on how much money they start with and accumulate over time, but also on the financial literacy skills they develop. So when choosing a custodial account, consider whether they provide educational content, and the quality of that content. Once the child takes control of the account, you want to be confident they will make sound financial decisions.
2. Submit an Application
To open a custodial brokerage account, you’ll just need some key identifying information about you and the beneficiary, such as date of birth and Social Security numbers. You’ll also need contact information and sometimes employment information, depending on the financial institution. The process is similar to opening a traditional brokerage account.
3. Fund the Account
If you’re funding the custodial account from a bank, have the account number and routing number on hand. You’ll need the brokerage account number and account type if moving assets from another brokerage firm. Minimum investments vary by company.
Related: Appreciating Assets: 10 Best Things that Appreciate in Value
Can You Open a Custodial Account Online?
Yes. Most brokers allow you to open a custodial account online. It’s typically a fast process—especially if you already have the necessary information at your fingertips.
Once the application is approved, you can easily fund the account online through bank transfers.
|
Robo-Advisor Micro-Investing App
|
Best Self-Directed Robo-Advisor
|
|
3.6
|
4.3
|
|
Acorns Premium: $12/mo. subscription required for custodial account.
|
Free for account balances >$10k, otherwise $3/mo.
|
How Much Money Do I Need to Start a Custodial Account?
Not much, usually! The minimum initial investment for a custodial account varies by provider. Fortunately, some providers let you open an account with only a few dollars.
Some custodial accounts require you to purchase full shares of investments, so you might need to wait until you’ve accumulated more money in the account to invest. However, there are custodial accounts that let you purchase fractional shares, meaning you can start investing with as little as $5 or sometimes even $1 right away!
How Do I Invest in a Custodial Account?
A select few custodial accounts will pre-select investments for you after you answer a series of financial questions. And a few others will provide you with an extremely limited number of investments (say, a handful of index funds or fund portfolios that cover a range of risk tolerances, from conservative to aggressive).
However, if your custodial account is similar to a brokerage account, you’ll be able to select from potentially thousands of stocks, ETFs, mutual funds, bonds, and potentially other assets.
Given that your child is likely many years away from needing any of the money from the account, your portfolio will have plenty of time to ride out any market volatility. So you can afford to be more aggressive—though you certainly don’t have to be if you’re uncomfortable with risk.
If you simply don’t think you’re capable of choosing investments, one of the easiest options is a target-date fund. These funds typically invest in a combination of stock and bond funds, and the assets change over time until a target year well in the future—simply invest in a fund with a year that’s closest to when the child is likely to retire. At the start, assets usually are more aggressive in hopes of building wealth, but as the fund nears its target date, management will shift the stock-bond mix to become more conservative and protect that wealth.
You can always ask a financial advisor for investment account feedback as well.
Related: 15 Best Income-Generating Assets [Invest in Cash Flow]
What’s the Difference Between a UGMA and a UTMA?
UGMA and UTMA accounts are quite similar, but UTMAs offer more flexibility in the types of assets they can hold:
- A UGMA account can contain financial assets such as cash, mutual funds, stocks, bonds, life insurance policies, and similar financial holdings.
- A UTMA custodial account can hold real estate and other asset classes in addition to financial assets.
Once upon a time you could pick either a UGMA or a UTMA account—but not anymore. Since April 2022, you can only establish a UTMA account. UGMAs that were established in the past are still around, and some brokers still advertise them.
But in the United States—unless you live in the territory of Guam—all new custodial brokerage accounts are UTMAs.
What Can I Buy in a Custodial Brokerage Account?
Investment options vary by custodial account provider. Some custodial accounts offer a broad range of choices, while others are more limited.
The most common investments to be found in a custodial account are exchange-traded funds, mutual funds, and stocks. You’ll sometimes also be able to invest in individual bonds, CDs, and more. And now that all custodial accounts are UTMA accounts, they can hold other assets, such as real estate.
However, you cannot buy and sell on margin (borrowing money to buy assets) in a custodial account, nor can you partake in other high-risk investment vehicles, such as futures, options, commodities, or derivatives.
Related: 7 Best Growth Stocks to Buy [Find Your Edge]
Does It Cost Money to Invest in a Custodial Brokerage Account?
Many providers charge zero account or maintenance fees for UTMA accounts. On rare occasion, you might be charged trading commissions, but unless you’re frequently making trades, these fees shouldn’t cut deeply into your profits.
In a handful of cases, some providers do charge monthly account fees. These providers tend to be firms that specialize in custodial accounts.
Related: Does My Child Have to File a Tax Return?
Custodial Accounts: FAQs
What are the tax implications of investing in a custodial account?
Tax implications can be broken down in two ways.
- For givers: In 2024, each parent or other relative can give the child $18,000 without paying any federal gift tax. This gift tax exclusion is estimated to rise to $19,000 in 2025. If you give more than that, and you must file Form 709 with the IRS … but you likely won’t owe federal gift taxes. That’s because any amount given over the annual gift tax exclusion is simply subtracted from the lifetime exclusion, which is $13.61 million for individuals and twice that for married couples. Only after you exceed that lifetime exclusion will you owe gift taxes.
- For minors: In 2024, investment income (interest, dividend, earnings) under $1,300 is untaxed. The amount from $1,300 to $2,600 is taxed at the child’s tax rate, which is much less than the parent’s rate and often 0%. Only if the unearned investment income exceeds $2,600 is any amount over $2,600 taxed at the parent’s rate—something referred to as the “kiddie tax.”
Note that taxes on gains only occur when the investments are sold.
The rules not only apply to children under age 18, but also people under age 24 that are full-time students.
What other types of investment accounts for kids should I consider?
If a custodial brokerage account isn’t your cup of tea, there are several other ways to help your child get ahead on saving.
529 plans
A 529 investment account is a tax-advantaged savings account specifically for higher education purposes. Money in these accounts can be used for college tuition and related costs; it can also be used toward primary- or secondary-school tuition, but only up to $10,000 annually.
You fund the account with post-tax money. The funds are then invested in mutual funds or other investments. The money grows on a tax-deferred basis, and distributions remain untaxed as long as the money is used for qualified education expenses.
A potential downside of these accounts is that if money is used for anything but qualified education expenses, the earnings are subject to tax and an additional 10% penalty.
Fortunately, the penalty is waived if the beneficiary earns a tax-free scholarship, dies, becomes disabled, or attends a U.S. military academy. The money can also be transferred to another qualifying family member, such as a younger sibling. Alternatively, it can be transferred to a 529 ABLE account for the beneficiary without any taxes or penalties.
Overall, these accounts have superior tax and education aid advantages over custodial accounts.
Education savings accounts
Coverdell education savings account (ESA) funds can be used toward private school tuition and fees, higher education expenses, and more. These accounts are similar to 529 accounts, but with a few significant differences.
The ESA annual contribution limit is just $2,000, whereas a 529 plan has no contribution limit (though gift taxes can come into play if you somehow exceed the multimillion-dollar lifetime exclusion cap mentioned above). Also, you can only contribute the full $2,000 to an ESA if your income is equal to or less than $110,000 (single) or $220,000 (married, filing jointly).
You must stop contributing funds once the beneficiary turns 18, and the funds have to be used by the beneficiary by the time they turn 30.
Another difference is that ESA accounts are often pretty flexible, allowing you to choose from thousands of stocks, mutual funds, and exchange-traded funds. Typically, 529 plans are limited to just a few preset options.
When can a custodian make withdrawals?
A custodian can make withdrawals from a custodial account at any time, but the withdrawn money must be used in a way that directly benefits the minor.
Custodians cannot make withdrawals for personal expenses. They also cannot use the withdrawn money to substitute any obligation they have as a parent or guardian to support the beneficiary, such as providing a child shelter or food. An example of an acceptable reason to withdraw funds might be to pay for braces a child needs.
But just because there are situations where it is possible to make withdrawals doesn’t mean it’s wise. Invested money can grow, so when possible, leaving it invested is the better option. Withdrawn money may also create taxable gains for the child.
Once the beneficiary takes control of the account, they can make withdrawals for any purpose, whether it be toward a house down payment, a dream vacation, or anything else.
Who can contribute to a custodial account, and are there limits?
Anyone can contribute to custodial brokerage accounts as long as they know their contributions become gifts the second they enter the account and cannot be taken back. Family members might choose to gift money to a custodial account rather than give a physical gift for a birthday or holiday.
There are no contribution limits for custodial accounts. In 2024, individuals can contribute up to $18,000 without having to pay gift tax or have the contribution count against their lifetime gift tax exclusion. Just note that money in a UTMA or UGMA account can affect financial aid eligibility.
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