By Kaye A. Thomas
Current as of July 8, 2016
An introduction to custodial accounts for minors, including terminology and basic concepts.
Basics of investing. Our book That Thing Rich People Do: Required Reading for Investors offers the easiest way to learn the principles of investing. It’s a short, readable book suitable for anyone who’s new to the subject, including a young adult or even a minor.
Uniform Transfers to Minors Act
Custodial accounts for minor children are set up under a state’s version of the Uniform Transfers to Minors Act, or UTMA. These state laws are all based on the same model, but with variations that prevent them from being entirely uniform. When we refer to the Act, we’re actually referring to the model on which these laws are based. It’s possible your state’s law will differ.
A previous version of this law was called the Uniform Gifts to Minors Act, and some people still use that name even though all states except South Carolina have adopted the more modern Uniform Transfers to Minors Act.
Custodial Accounts vs. Trusts
Custodial accounts are similar in some ways to trusts. Both place property under the control of a person who manages it for the benefit of someone else. 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.
Despite being similar, custodial accounts are not trusts. In fact, the whole point of 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.
Sometimes it makes more sense to use trusts because they provide greater protections and more flexibility. In particular, you should think of using a trust when you expect to transfer large sums. Custodial accounts are more suitable for smaller transfers.
A transfer to a child under UTMA 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 custodian can be the person setting up the account, or some other adult who has agreed to act in that capacity, typically but not necessarily one of the child’s parents. 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.
Setting up a custodial account
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.
If you need to specify the age at which the account terminates (see below) you would add after the minor’s name “until age 21” or similar language. The financial institution where you set up the account should be able to help with the mechanics.
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. (A custodian who abuses the account can be taxed on the income, however.)
The custodianship 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 custodianship terminates, the custodian transfers control the child, who can use the account as he or she chooses.