Give a gift to a minor—and introduce investing
A custodial account can be an excellent way to make a financial gift to a child, whether they are your own, a relative’s or a friend’s. This type of account, established under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), is set up by an adult for the benefit of a minor.
Once the account is opened, it can provide an opportunity to involve the child in basic investing. You might talk about goals and discuss investment choices. You could also review account statements and discuss gains and losses.
Important basic information about custodial accounts
Although the general principles for custodial accounts are the same across the country, the age when a child can take control of the account and assets (also called the "age of majority") varies from 18 to 21, and is sometimes even older, depending on the circumstances and the state. Be sure to ask a financial consultant about the law in your state.
Here are other important details you should consider:
- Custodial accounts are simpler to establish than trusts, which generally require more planning and the help of an attorney. However, a trust can offer more flexibility, control, and protection than a custodial account.
- In 2009, anyone can give a monetary gift of up to $13,000 (or $26,000 per couple splitting gifts) to each recipient without incurring federal gift tax. (This rule applies to custodial accounts as well as other forms of gifts.)
- As the donor, you can designate yourself or another adult to be the custodian of the account. If the donor acts as the custodian, and he or she dies before the account terminates, the account value will be included in the donor’s estate for estate tax purposes.
- The custodian has sole responsibility to manage the assets for the minor until the custodianship ends, usually when the minor reaches the age of 18 or 21, depending on the state.
- All custodial assets must be used "for the use and benefit of the minor." While this may be subject to interpretation, it’s clear that custodians should never use the money for expenses unrelated to the child’s interests, or for day-to-day living expenses and other expenses the custodial parent or legal guardian is legally obligated to pay. If the custodian is the child’s parent or legal guardian, then it’s advisable to get advice from a financial consultant regarding allowed distributions before making any withdrawal from the account for the benefit of the child.
- Money and assets deposited into a custodial account immediately become property of the child. This is not revocable. In other words, you can’t change your mind, take the assets back or give the assets to someone else. If circumstances arise that require a change, the custodian should seek legal advice before making any changes.
- The account must be turned over to the child once the custodianship ends. (At that time, the custodian’s access to the account may be restricted.) The child will then have complete control over the account. He or she may choose to sell any investments in the account or close the account and request a check for the proceeds. Alternatively, he or she may convert the account to his or her own name, establish the custodian as a joint account holder, or grant the custodian power of attorney on the account.
- Any investment income—such as dividends, interest or earnings—generated by account assets is considered the child’s income and taxed at the child’s tax rate once the child reaches age 18. If the child is younger than 18, the first $950 is untaxed, and the next $950 is taxed at the child’s rate. Anything over $1,900 is taxed at the parent’s rate.
- Custodial accounts don’t let you designate what happens to the money in the account if the child dies before receiving it (it is part of their estate and distributed according to the laws of your state). With a trust, however, you may make this decision.