What Is A Custodial Account And Should You Use One?

The greatest wealth transfer in history is already well under way. The research firm, Cerulli and Associates, estimates that $84 trillion will be passed on from the Baby Boomer and Silent Generation between now and 2045. The majority of these assets are expected to go directly from parent to child, with the most coming from Baby Boomers and going to millennials. However, Generation Alpha (those born between 2010-2025), are already on the receiving end from both their parents and grandparents.

Estate planning and gifting strategies all fit neatly within the current wealth transfer narrative. Today’s seniors have far more wealth than their parents or grandparents did in their later years. Conversely, rising generations are expected to have a harder financial start. Whether it is joining the student loan epidemic with a bachelor’s degree that routinely exceeds six figures, paying for a wedding that costs on average $33,000 in 2024, or trying to become a first-time homebuyer.

As parents and grandparents welcome a new baby into their family, the impulse to help financially has never been stronger. The financial industry is meeting this trend with a barrage of vehicles from 529 college savings plans, savings bonds, CDs, juvenile life insurance policies, trust accounts, and more. Many of these products blend together in an overall gifting plan for young beneficiaries and are beyond the scope of this article. But one account often mistakenly confused as the catch-all for kids that warrants clarification is a custodial account.

What is a custodial account? A custodial account is a financial account that allows a person to transfer assets to a minor beneficiary. The custodian, typically a parent or guardian, manages the property on behalf of the underage beneficiary. In this respect, it is similar to a trust, but without any of the trust paperwork and attorneys.

There are two different types of custodial accounts: The Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA). UTMA accounts are more common as they can hold nearly any type of asset including real estate, and most states no longer use UTMA accounts. The UTMA account can hold cash, art, personal property, stocks, bonds, mutual funds, and more.

There are no contribution limits to a custodial account. Many people hear about the annual gift tax exclusion, currently $18,000 per person per recipient in 2024 or $36,000 for a married couple gifting to one child, and mistake this as a limit. All this means is that any gift exceeding $18,000 can require the filing of a federal gift tax return. This is often not as bad as it sounds either. The 2024 lifetime estate tax exemption is $13.61 million, and it is portable, meaning a married couple can protect up to $27.22 million from estate tax. When someone makes a gift to one person over $18,000, the overage is deducted from their lifetime estate tax exemption.

Should every parent or relative looking to gift use a custodial account? Perhaps the most important consideration about custodial accounts is that any transfer into the account is irrevocable and the transferor cannot access the asset. If the transferring parent/guardian or grandparent runs into financial trouble, changes their mind about their estate planning goals, no longer wants to leave money to the child for whatever reason, they are stuck as what is done is done. A custodial account is controlled by the custodian and terminates when the minor beneficiary reaches the age of majority (typically age 18 or 21). An important concern is if the custodial account assets are significant, and the 18 or 21-year-old beneficiary is not financially mature when he or she takes full possession of the assets.

So, what are the tax benefits, or lack thereof, of a custodial account? One of the advantages is that in 2024 up to $1,300 of any earnings (interest, dividends, or capital gains) may be exempt from federal income tax, earnings over $1,300 but less than $2,600 would be taxed at the child’s rate which is often lower than the custodian’s, and anything over $2,600 would be taxed at the parent’s rate. This is known as the “kiddie tax.” If the child has income that exceeds certain thresholds, the parent may need to file a separate income tax return for the child. From an estate tax planning standpoint, custodians must realize that transferring assets into the child’s account does not remove the assets from the transferor’s estate when the transferor is the custodian. Lastly, it is worth noting that custodial accounts are considered an asset of the child and may affect their eligibility for financial aid.

Like many financial vehicles, the goals and benefits may be in opposition with one another. For instance, a parent wants control but also tax benefits, they want to help the child but with flexibility for an uncertain future. The reality is that they may satisfy one goal while giving up another. This necessitates coordination with financial professionals for an overall financial and estate plan unique to each client.

CFP, LUTCF, is an investment adviser representative with Kuderna Financial Team. He is a perennial qualifier for the industry's prestigious Million Dollar Round Table®, Leaders Club, and Inner Circle. He is the author of the best-selling book, MILLENNIAL MILLIONAIRE- A Guide to Become a Millionaire by 30.Kuderna has a Bachelor of Science in Finance and Economics from The College of New Jersey. He has also studied at The University of Tampa and The University of Economics in Prague, Czech Republic. He is a featured speaker nationwide at college campuses, teaching hospitals, government offices, syndicated talk radio shows, and major publications on the subjects of financial literacy, millennial business, networking, and personal development.Kuderna can be reached at Kuderna Financial Team, 1040 Broad Street, Ste. 202 Shrewsbury, NJ 07702. Phone: 848-456-3057. Email: bkuderna@planningalliance.com.