Introduction to a Custodial Account for Kids and Teens
This video explains the concept of a custodial account in a simple, concise way for kids and beginners. It could be used by kids & teens to learn about custodial accounts, or used as a money & personal finance resource by parents and teachers as part of a Financial Literacy course or K-12 curriculum.
Suitable for students from grade levels:
- Elementary School
- Middle School
- High School
The topics covered are:
- What is a custodial account
- Different types of custodial accounts
- How does a custodial account work
- What are the advantages of a custodial account
- Are there any disadvantages of a custodial account
What is a custodial account?
Generally, a custodial account refers to any financial account – like a savings account at a bank or a brokerage account – that is opened and operated by one person on behalf of another.
In most cases, it refers to an account where an adult – usually a parent, grandparent, or guardian – controls the account on behalf of a child under 18.
Normally, minors who are less than 18 years old cannot invest money, but they can if they use a custodial account.
Are there different types of custodial accounts?
There are 2 main types of custodial accounts.
Uniform Gift to Minors Act, or UGMA accounts can be used to invest only in financial assets like stocks, bonds, mutual funds, annuities, and insurance policies.
Uniform Transfers to Minors Act, or UTMA accounts can be used to invest in a variety of assets including real estate, intellectual property, patents, art, etc. in addition to financial assets.
How does a custodial account work?
A child’s parent or guardian can easily open a custodial account either online, or by visiting a bank or brokerage and filling up some minimal paperwork, along with depositing the initial amount.
This person controls the account and is called the custodian. The real owner of the account is the child, who is known as the beneficiary. The custodian needs to authorize all transactions, and must act in the best interest of the beneficiary.
When the child becomes 18 or 21 (depending on the state), full control of the custodial account is passed on to them.
What are the advantages of a custodial account?
Their biggest benefit is that they allow minors to invest. By starting the investing journey early, a child can take advantage of the magical power of compounding.
Custodial accounts can also be a very useful tool to teach kids about money management and investing.
Another advantage is that anyone can contribute to the account – family, friends, or the custodian. There is no contribution limit or withdrawal penalty, although any withdrawals made need to be for the benefit of the minor.
While custodial accounts don’t have the tax benefits of a 529 account or a 401(k) account, they do offer some tax benefits – a part of the income is tax exempt, and some income is taxed at a lower child tax rate.
Are there any disadvantages of a custodial account?
Having a custodial account can impact the minor’s chances of financial aid for college.
Another disadvantage is that the beneficiary cannot be changed under any circumstance. When the child reaches the age 18 or 21, they get full control of the account and if they are not responsible with the money, there is nothing the parent or guardian can do.
They also don’t offer significant tax benefits such as those offered by tax advantaged accounts like 529 or 401(k).