a man holding a jar with a savings label on it by Towfiqu barbhuiya courtesy of Unsplash.

Custodial Accounts for Minors: Tax Implications and Benefits

Wooster Corthell |

As parents and guardians, one of our biggest goals is to ensure a prosperous future for our children. Custodial accounts stand out as a practical financial tool in achieving this objective.

What Are Custodial Accounts?

A custodial account is a financial account set up for the benefit of a minor (a person under the age of 18 or 21, depending on the state) with an adult as the custodian. These accounts come in two main forms: the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) accounts. These accounts can hold financial assets like stocks, bonds, and mutual funds.

How Do They Work?

The custodian’s role is to manage the funds on behalf of the minor until they are a legal adult. Funds in these accounts can be used for expenses that benefit the child, including education, healthcare, and general welfare. It’s important to note that once money is placed in a custodial account, it cannot be taken back and must be used solely for the benefit of the minor.

Tax Advantages

  • Taxed at the Child's Rate

Custodial accounts offer unique tax benefits, which make them an attractive option for saving for a child's future.

One of the key advantages is that earnings in a custodial account are taxed at the child's tax rate, which is typically lower than that of the adult custodian. The first $1,100 of unearned income in a custodial account is tax-free, the next $1,100 is taxed at the child’s tax rate, and any income above $2,200 is taxed at the custodian's (typically the parent's) rate.

  • Gift Tax Exemption

Contributions to a custodial account qualify for the annual federal gift tax exclusion. For 2024, this means that up to $18,000 per year ($36,000 for couples filing jointly) can be contributed without triggering the gift tax.

Limitations and Considerations

  • Impact on Financial Aid

One potential downside to custodial accounts is their impact on college financial aid. Since these accounts are considered assets of the child, they can reduce eligibility for need-based financial aid more than if the assets were held in the parents' names.

  • Irrevocable Gifts

It’s crucial to remember that funds placed in a custodial account are irrevocable gifts to the child. When the minor reaches legal age, they gain full control over the account and can use the funds as they wish.

Custodial accounts offer a blend of flexibility, tax advantages, and simplicity in saving for a child’s future. However, it’s important to weigh these benefits against potential limitations, such ashow it impacts financial aid. Understanding these nuances can help in making an informed decision that aligns with your long-term financial goals for your child.

Ready to take the next step in securing your child's financial future? Book a meeting with Wooster Corthell today, and let's discuss how custodial accounts can be a strategic part of your family’s financial plan. Together, we can pave the way for your child's prosperous future. For more financial insights and tips, follow Wooster Corthell on LinkedIn.

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The author generated this text in part with OpenAI’s large-scale language-generation model. Upon generating draft language, the author reviewed, edited, and revised the language to their own liking and takes ultimate responsibility for the content of this publication.