If you want to give your child a head start on saving, consider opening a “custodial account” for her. This type of account can set her up for long term growth ahead of her own years of investing.
A Custodial Account?
A custodial account is an account in your child’s name, that is managed by a parent/legal guardian or other relative. A custodial account is a great way for parents to save money for their child starting when they are very young. The adult manages the account until the child is of age, which varies from state to state.
Custodial accounts are very flexible and have multiple options for how the custodian will manage the account. The two acts that regulate custodial accounts in the U.S. are the Uniform Transfers to Minors Act and Universal Gifts to Minors Act (UTMA or UGMA).
You can use custodial accounts as a vehicle to save for your child’s future college costs. This is similar to the Section 529 account you might be familiar with.
UTMA’s and UGMA’s
But the UTMA and UGMA accounts are different in how the assets can be used. You can use these funds, and the accumulated earnings, for non-education related items such as college application fees or transportation. Additionally, there is no penalty if you don’t use the account for college expenses. This means you can also use this money to give your child a big advantage on their road to a wealthy future.
Remember, once the child reaches the age of majority, they can use the money for any purpose whatsoever without obtaining the permission of the custodian. You should be clear about this before setting up this type of account for your child. Also, you can’t transfer UTMA and UGMA funds to another individual. This is another big difference from the 529 account option.
The Pros and Cons
There are a pros and cons to opening a custodial account for your child. A custodial account is easy to establish and you can invest in a variety of assets.
The custodian (parent, guardian) will decide how to invest the account. So it’s important that you understand what assets to invest in to help the account grow over time.
Also, there are no income or contribution limits. You don’t need to make any regular or recurring distributions from the account.
Be sure to check out all of the tax implications of opening a custodial account for your child. UTMA/UGMA accounts don’t have the same tax advantages of a 529 account.
Finally, remember that you must pass all of the assets in the account onto the child at the mandated age. Have regular discussions with your child on how they can manage the assets for maximum benefits once they become the owner.
Before You Take the Custodial Leap
The most important take away is to make sure you fully understand the implications of opening a custodial account. Do your research and consult a financial advisor if needed.
In the best case scenario, you would involve your child in all aspects of the account management from the beginning. If your child is invested in the management of their account, chances are they will make wise decisions on how they will use the assets when the time comes!
