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What is a custodial account?

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As a parent, you always want to set your child up for success. And with that comes a desire to build their confidence and teach them life skills that can help them thrive.

Financial skills are a big part of that—especially in teaching financial literacy and emphasizing the stability that comes with long-term savings. Opening a custodial account for them can help you accomplish these goals.

What is a custodial account & how does it work?

A custodial account is a financial account that an adult—typically a parent or grandparent—opens on behalf of a minor child. These accounts exist because minors can't legally open accounts for themselves. An adult must be on the account with them. The adult responsible for overseeing and managing the account is the custodian.

Custodial account funding & asset types

Anyone can contribute to the custodial account—whether that's the custodian, the child or someone else. The type of custodial account determines how the account can be funded and what types of assets it can hold. Possibilities include gifts of cash, securities, real estate and tangible valuables as well as the child's earned income and investments purchased with that income.

Asset ownership

The child can't engage in account transactions (such as withdrawing funds or purchasing investments) on their own before the age of majority. However, the assets in the custodial account belong to the child at all times.

Custodian responsibilities

As long as the child is a minor, the custodian controls the account. All account activity must be for the child's benefit. The custodian may want to keep a detailed transaction record in case questions arise about the use of funds.

Age of majority

When the child reaches the age of legal adulthood in their state (typically 18 or 21), the account ceases to be custodial. The adult may need to notify the financial institution of this change, but they ultimately pass over full control of the account to their adult child.

Income tax responsibility

A custodial account technically belongs to the child. Any income it earns is reported to the IRS under the child's Social Security number. Income exceeding $2,500 may be taxable.

Types of custodial accounts

Many types of accounts allow adults to transfer assets to minors and manage them on their behalf. In addition to custodial checking and savings accounts that you can use to work on foundational financial concepts, you may want to consider these specific custodial savings and investment accounts:

Uniform Transfers to Minors Act (UTMA) account

Laws in all 50 states allow for gifts of cash, securities and physical assets to minors through UTMA accounts. (A similar but more restrictive account called an UGMA, named after the Uniform Gifts to Minors Act, is no longer widely used.) The assets in an UTMA can be used for any purpose.

Opening an UTMA can be a good way for family members who may be subject to estate or inheritance taxes to preserve assets for younger generations. UTMAs also can be advantageous for directly transferring securities without having to sell them first.

These accounts have no contribution limits. But gifts exceeding the annual gift tax exclusion ($18,000 per recipient in 2024) must be reported to the IRS and count toward the lifetime gift tax exclusion limit ($13.61 million in 2024).

Coverdell Education Savings Account (ESA)

A Coverdell ESA can help families save for a child's K–12 or post-secondary educational expenses. You can use a Coverdell ESA alone, but with its low annual contribution limit of $2,000 per beneficiary (not per donor), it's often used to supplement other accounts, such as UTMAs and 529 plans.

Unlike UTMAs, Coverdell's allow tax-deferred growth. Withdrawals aren't taxed when the money is spent on qualified educational expenses at an eligible institution. Individuals whose modified adjusted gross income exceeds annual IRS limits can't contribute to these accounts, however. For 2023 and 2024, those limits are $110,000 for single taxpayers or $220,000 if married filing jointly.

Custodial Roth IRA

If your child earns income, they can contribute to acustodial Roth IRA no matter how young they are. The limit for 2024 is $7,000 or 100% of earned income, whichever is less. You can invest the money in the account, and growth isn't taxed.

You can withdraw contributions without penalty on behalf of your child at any time, or they can once they reach legal adulthood. They also can withdraw earnings free of taxes and penalties for any reason once they reach age 59½. Or penalty-free (but not tax-free) before then for:

  • Eligible college expenses
  • Qualified birth and adoption costs
  • Unreimbursed medical expenses while they're unemployed
  • Disability needs

Advantages of opening a custodial account for a minor

Setting up a custodial account for your child can be a great idea at any age. The earlier you start, the more teaching opportunities you may have and the more years the earnings may have to compound. Here are some other advantages of these accounts:

Simpler than trusts

Trusts are another vehicle for transferring assets to a child. Trusts are suitable in many circumstances, but they're more complicated and costly to establish and manage. It can be more challenging to teach a child financial responsibility through a trust than through a custodial account. That said, you can have both.

Many asset choices

Custodial accounts can hold cash, stocks, bonds, mutual funds, certificates of deposit (CDs) and other securities. They even may be able to hold real estate and other types of assets. Options vary by type of custodial account, financial institution and state law.

Potential tax savings

When assets within a custodial account generate earnings, the first $2,600 may be taxed at the child's rate (as of 2024), which may offer your family tax savings compared to holding the assets in an adult's name.

Collaborative & flexible

Custodial accounts tend to be designed, in part, so that almost anyone can contribute. It's a way for anyone who cares about your child to give them a financial boost for their future. Plus, depending on the account you set up, you and your child either can use those funds for a specific purpose, such as education expenses, or allow your child to use them for anything once they're a legal adult.

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Disadvantages of custodial accounts

Custodial accounts aren't the right choice for every situation. As a parent considering a custodial account for your child, understand their limitations before placing assets in them.

College financial aid

Because a custodial account belongs to the child, college financial aid formulas expect a significant percentage of the account to go toward higher education expenses. If you want your money to go further to help a child pay for college, you may be better off contributing to a 529 savings plan instead of (or in addition to) a custodial account.

Limited control

You can't transfer a custodial account to another child, nor can donors take back their contributions. Further, you can't withdraw the funds to use for a purpose that doesn't benefit your child. If it becomes apparent that your child may not be able to manage the money wisely when they gain full control of the account, you may not have as many options as you'd like for protecting the funds.

Gift tax implications

As noted earlier, parents and other family members who want to contribute to a child's custodial account should be aware that gifts larger than the annual exclusion amount count against the donor's lifetime estate tax exclusion.

Set your child up for financial success

With up to 21 years to manage a custodial account for your child, you could accumulate enough assets to help them flourish in any number of ways: attending their dream school, traveling abroad, starting a business and more. They're a great way for extended family to offer their support, too.

While a custodial account places a great deal of financial responsibility on your child in the coming years, it also presents an opportunity to teach wise money management now. To discuss custodial accounts and other options for investing in your child's future, connect with a Thrivent financial advisor.

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Investing in securities involves risks such as fluctuating principal, and they may lose value. CDs offer a fixed rate of return. The value of a CD is guaranteed up to $250,000 per depositor, per insured institution, by the Federal Deposit Insurance Corp. (FDIC), an independent agency of the United States government.