An introduction to custodial accounts for minors, including terminology and basic concepts.
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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. Your state’s law may differ in some respects. The most important variation is in the age at which the minor gains control of the account.
A previous version of this law was called the Uniform Gifts to Minors Act, or UGMA, 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 let you avoid having to establish and manage a trust, which is more expensive, complicated and time-consuming. In some cases, though, it makes more sense to use a trust for greater protections and more flexibility.
Think of using a trust when you expect to transfer large sums. Custodial accounts are more suitable for smaller transfers.
The adult who manages the account for the child is called the custodian. This can be the person setting up the account, or some other adult who has agreed to act in that capacity. Typically the custodian is one of the child’s parents, but it can be some other relative or even an unrelated adult.
The custodian manages the account, making decisions concerning buying and selling investments, reinvesting earnings and so forth. The custodian may also take money from the account to spend for the benefit of the child. When the child reaches the specified age, the custodian transfers control of the account to the child.
Setting up a custodial account
Custodial accounts are welcome at most banks, brokerage firms and similar financial institutions. The account is usually funded with cash, but it’s also possible to transfer stocks or other assets. To show that it’s a custodial account, it would have a designation something like this:
John Smith, as custodian for Mary Smith, 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: cash and assets held in a custodial account are owned by the child. Even though the child will not have control until later, the child is the owner as soon as cash or other assets are transferred to the account. The custodian is merely a manager of an account owned by the child. 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.
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 to the child, who can use the account as he or she chooses.