Custodial Accounts 101


By Kaye A. Thomas
Updated May 30, 2013

A brief overview of UGMA and UTMA custodial accounts.

This page offers a general explanation of custodial accounts for minors, introducing the terminology and basic concepts.

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Uniform Laws

To begin, you need to know that uniform laws aren't entirely uniform. A group of lawyers, judges and law professors known as the National Conference of Commissioners on Uniform State Laws proposes them, and it's up to the individual states to determine whether they'll adopt them and what changes they'll make. If two states adopt the same uniform law, you can expect to see similar but not identical laws in those two states.

As a result, statements that are true about a uniform act are not necessarily true about the law of your state. For example, a custodial account may terminate at age 18 in one state or at a later age in another state. Before you rely on anything you read here, check the law of your state.

On the web site for the National Conference of Commissioners on Uniform State Laws you can read the text of the Uniform Act (PDF).

Uniform Gifts vs. Uniform Transfers

The Uniform Law Commissioners adopted the Uniform Gifts to Minors Act (UGMA) in 1956. The primary focus then was to provide a convenient way to make gifts of money and securities to minors. Later, it became clear that a more flexible law was desirable. The Uniform Law Commissioners adopted the Uniform Transfers to Minors Act (UTMA) in 1986. UTMA expands the types of property you can transfer to a minor, and provides that you can make other types of transfers besides gifts.

Nearly all states have adopted UTMA, but sometimes people still refer to the Uniform Gifts to Minors Act because they're used to that name. For our purposes it doesn't matter which law prevails in your state because the essential principles of both acts are the same.

Custodial Accounts vs. Trusts

Custodial accounts are similar in some ways to trusts. Both place property under the control of a person who isn't the beneficial owner — that is, the person who has the ultimate right to enjoy the fruits of the property. In the case of a trust, a trustee manages the property for the benefit of the beneficiaries. In the case of a custodial account, the custodian manages the property for the benefit of the minor.

Yet custodial accounts are not trusts. In fact, the whole point of UGMA and UTMA is to permit you to transfer property to a minor without establishing a trust. The legal framework for trusts is much more elaborate than for custodial accounts. Generally speaking, trusts are more expensive, complicated and time-consuming than custodial accounts.

There are good reasons to use trusts in many situations, however. Trusts provide greater protections and more flexibility. Generally you should think of using a trust when you expect to transfer tens of thousands of dollars. Custodial accounts are more suitable for smaller transfers.

Custodians

A transfer to a child under UTMA or UGMA requires the involvement of a custodian. This is an adult who will manage the property until the child reaches the age when control passes to the child. The person transferring property to the child can act as custodian or name another adult to act in that capacity. The custodian manages the property, making decisions concerning buying and selling, reinvesting earnings and so forth. The custodian may also take money from the account to spend for the benefit of the child.

Transfers

There are various ways to make the transfer. If the property consists of cash or other financial assets (such as stocks and bonds), a common method is to open a custodial account at a financial institution such as a bank, brokerage firm or mutual fund company with a designation something like this:

John Smith, as custodian for Mary Jones, under the Illinois Uniform Transfers to Minors Act.

The financial institution where you set up the account should be able to help with the mechanics.

Ownership

It's important to understand the following: property held in a custodial account is owned by the child. Even though the child will not have control of the property until later, the child is the owner as soon as property is transferred to the account. This fact has important consequences:

  • A gift is legally complete when cash or other property is transferred to a custodial account, not when the account terminates. You aren't allowed to change your mind and take the property back.
  • Income generated by assets in the account is the child's income. (If you abuse the account, you can be taxed on the income, however.)

Termination

The account terminates when the child reaches a specified age. The age depends on your state's law, and may depend on the type of transfer. In some states you can choose to designate a different age than the one that automatically applies, but the law will impose a limit on the age you can choose. For example, in California an account established by gift will terminate when the minor attains age 18 unless you specify a later age, up to age 21. (A custodial account established in California under a trust or will can terminate as late as age 25.)

When the account terminates, the custodian transfers control of the property to the child, who can use it in any way he or she chooses.