The Fool FAQ

Custodial Accounts

The Fool FAQ

I've heard of custodial accounts but I'm not clear on exactly what they are or how they work. Is there a TMF in the house who can help me learn more?

These are investment accounts opened for the benefit of children. There are some very specific rules governing these accounts. Let's take a look!

Custodial accounts, like IRA's, are accounts held by a custodian for the benefit at some time in the future of another party. Unlike IRA's, these accounts are not tax deferred. The account, while held with an adult as custodian, is in the child's name, and registered under the child's social security number. Therefore, any gains will be taxed at the child's rate. (See The Kiddie Tax .) As you invest, this must be kept in mind as any sales with profits will be a taxable event.

The age of maturity is the catalyst for the relinquishing of the funds. Each state has its own laws, although most carry the 18 year old law. However, that is the least time period the account can be held in custodianship. The majority for the institution holding the account can, and does, vary. For instance, Smith Barney's age of majority is 21. This doesn't eliminate access if funds are used for college, or emergencies. With the 21 year majority, the child can't have the money at 18 to, say, buy a car.

Opening a custodial account is simple. Any brokerage firm will be willing to aid you in this. All that is required is one custodian and one child per account, the child's social security number, birthdate, and the custodian's employment information as well as the child's risk tolerance and objectives.

There are 2 types of custodial accounts. One is opened under the Uniform Gift to Minors Act, or UGMA, and the other is opened under the Uniform Transfers to Minor's Act or UTMA. These are just 2 different ways to describe the laws, and are virtually interchangable. One simply designates the gift, while the other is a transfer of assets. Generally one starts with cash, while the other has stocks transferred in from an adult's account.