Best Custodial Accounts to Save for Your Children's Future

We work hard to secure our financial futures by paying off debt and saving for retirement. You can also give your children a head start on a secure financial future by signing up for a custodial account that you and others can put money and other assets into to secure their future. 

However, a custodial account differs slightly from a standard checking account, and finding the best custodial accounts to save for your children’s future can be difficult. 

To streamline this process, our guide outlines what a custodial account is, how they work and how to find the right one for you. 

What is a custodial account?

A custodial account is a savings account an adult opens and manages for a minor under 18 or 21, depending on local laws. These accounts can be from a traditional banking financial institution, a mutual fund company or even a brokerage firm. 

Generally, custodial accounts are free of most limitations, including income limits, federally mandated contribution limits and withdrawal penalties. They also don’t require distributions at any point, and any money put into the account cannot be removed until the child reaches the age of majority and withdraws the money themself. 

The account custodian — typically an investment manager at a brokerage — must give permission for all transactions until the person for whom the account was opened turns the age of majority. The custodian operates as a fiduciary, ensuring only the best investments are made to help grow the account.

What types of custodial accounts are there?

There are two primary types of custodial accounts: Uniform Transfers to Minors Act (UTMA) and The Uniform Gift to Minors Act (UGMA). Let's dig into each account to see how they differ and to help you decide which is best for you. 

What is a UTMA?

A UTMA is a relatively wide-open account regarding the assets the custodian can contribute to the account. This can include unusual items, such as real estate and art. UTMAs also have no contribution cap, so you can put aside as much as you'd like for your child.

UTMAs are relatively simple to transfer to the beneficiary when they reach the age of majority, which is usually 21 years old. 

Keep in mind that UTMAs aren't available in all states, so check your local laws to see if they’re permitted. 

What is a UGMA?

UGMA accounts aren’t as freewheeling as UTMA accounts, as they generally limit contributions to more secure assets, including:

• Cash 

• Securities 

• Index funds 

• Exchange-traded funds (ETFs) 

• Insurance policies 

Investments that pose significant risks are generally not allowed. 

The account beneficiary is considered an adult at 18 years old and can take full control of the UGMA. 

The final key difference is UGMAs are available nationwide. 

How do you sign up for and use a custodial account?

You can sign up for a custodial account at a wide range of banks, credit unions or brokerages — both online and brick-and-mortar institutions. Once you complete the initial sign-up, you must fund the account to the required minimum amount with assets. Depending on the type of account you opened, this can be cash or physical assets. 

From that point forward, anyone — friends, family members, parents and others — can put virtually any amount of cash they'd like into the custodial account as a gift. Keep in mind, though; some custodial accounts have $15,000 contribution caps per year to account for gift-tax laws. For married couples, that cap can rise to $30,000 per year. 

Remember that all contributions to a custodial account are non-revocable, meaning once you commit an asset to it, you can’t take that asset back. However, you can use the custodial account for the benefit of the minor. Because of the vagueness of this wording, it's best to speak with a financial advisor before making any withdrawals.

What are the pros of a custodial account?

Plenty of good reasons can drive you toward getting a custodial bank account to start investing in your child's future. Here are some of the key benefits of a custodial account. 

Relatively limit-free

Most investment accounts have limitations restricting what you can do with the cash you invested. Custodial accounts usually have very few restrictions like the lack of legal caps — some do have self-imposed yearly caps to account for gift-tax laws — and the ability to withdraw cash to benefit your child at any time without penalty.

Flexible

Unlike other accounts that benefit children, such as college savings accounts, custodial accounts are very flexible. They can serve as a college savings plan, a trust and more. 

For example, if you open a 529 college savings account but your child decides not to attend college, there may be a penalty for using the cash for any non-approved reason. If you used a custodial account instead, your child could use the money as they see fit once they reach the age of majority and take control of the account. 

Tax benefits

A custodial account has tax advantages for the beneficiary that can help save cash over time.

While the child is under 18 years old, the first $1,100 in investment income from the custodial account is untaxed. The next $1,100 in unearned income is subject to income tax at the child's tax rate. It's not until the investment income exceeds $2,200 that it's taxed at the parent's tax rate. 

Easy to set up

A custodial account is significantly simpler to set up for beginners than a traditional trust in a child's name. They also don't require lawyers, making custodial accounts a more affordable option too. 

What are the cons of a custodial account?

The pros of a custodial account are enticing, but there are a few drawbacks to be aware of. 

Financial aid

If your child is planning to attend college and fills out a Free Application for Federal Student Aid (FAFSA), they must claim their custodial account as an asset. If the account has a high enough value, your child may be disqualified from grants and affordable student loans. 

Irrevocable 

Once you deposit money into a custodial account, it’s legally the child's money. The parent can’t decide to take money out or close the account. Once the child is an adult, they can use the money as they'd like, and the parents have no recourse.

Tax breaks

While there are tax advantages to a custodial account, even the best custodial accounts have no immediate tax breaks. Plus, once your child becomes an adult, they’ll have to pay taxes on the interest the account earns. 

Limited investment options

While certain custodial accounts have a broad range of investment options, many forbid high-risk investing like options trades. This ensures the account avoids large losses but can also limit its growth.

What to consider when choosing the best custodial account

There is no black-and-white answer to picking the best custodial accounts, but there are some variables to consider in your search.

Account fees

Account fees are among the first things to look into when choosing the best custodial account. Many financial institutions offer low monthly fees — some are as low as $1 per month. However, you also want to consider transaction fees. Each time you make a trade, is there a fee involved? 

Accessibility

Being able to access the account from anywhere may be important to many. The best custodial accounts could be with companies offering intuitive websites and mobile apps. 

Account minimums

Be aware of any account minimums, including the minimum amount to open the account and the minimum required balance. Failure to meet the latter could result in additional account fees. 

Investment options

Some custodial accounts have countless investment options, making them great for savvy investors. Others offer limited choices, making it easier for a beginner to get in and start growing the account. Choosing one with the investment options that match your experience level will help you choose the best custodial account. 

Set your children's personal finances on the right path

Whether you're planning to fund your children's college education, start transferring wealth to them or both, a custodial account may be a good option to pull this off. These accounts allow you to move wealth into an account seamlessly on your own until your kids reach the age of majority. 

Until they reach that age, you, your family and friends can add funds to this account and watch it grow with careful investing. One key to success is to find the best custodial accounts to save for your children's future goals.

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