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What Is a Custodial Brokerage Account?
Parents and guardians eager to set their children on a path toward financial independence might consider a custodial investment or brokerage account.
Like traditional brokerage accounts, these custodial accounts provide a way to buy and sell stocks, bonds, exchange-traded funds (ETFs), and other securities. Because minors are not eligible to open their own brokerage accounts, parents and guardians can open a custodial account in a child's name and manage the activity.
Custodial accounts provide an excellent opportunity to explore the principles of investing with a child. They can be a useful and important part of a foundational financial education. Children who learn how to manage, save, invest, and spend money can establish valuable lifelong money habits and enjoy a solid financial future.
Read on to learn about the different types of custodial brokerage and investment accounts available, how to choose a brokerage firm, how to open the account, and how to manage and fund the account.
Key Takeaways
- Opening a custodial brokerage account allows parents or guardians to introduce children to investing at an early age.
- Factors to consider when selecting a brokerage firm for a child’s account include fees, investment options, and educational resources.
- The process of opening a custodial account involves providing personal and banking information and completing a series of forms online.
- Funding options for custodial accounts include cash, stocks, and mutual fund transfers.
- Teaching children about investing means educating them about long-term financial planning and involving them in the investment decision-making process.
Understanding a Custodial Brokerage Account
A custodial account allows a minor to own assets in a brokerage account while at least one parent or guardian manages and controls the account until the child reaches the legal age of majority.
Although the child does not manage the account, the assets in the account do belong to the minor, and capital gains related to the account are taxed in the child's name.
There are different types of custodial accounts available, with important distinctions between them. These include varying purposes, requirements, restrictions, and fees.
Below is an overview of several of the types of custodial investment accounts for minors.
Types of Custodial Accounts
Custodial Brokerage Account
A custodial brokerage account is a type of investment account with few restrictions regarding income and contribution limits, distributions, and withdrawal penalties.
The custodian makes all investment decisions related to the account until the minor reaches the age of legal majority (typically either 18 or 21, depending upon the state). At that point, the minor claims full control of the account and use of the funds.
There are two primary types of custodial brokerage accounts:
- Uniform Transfers to Minors Act (UTMA) accounts, which may hold virtually any type of asset, from traditional investment vehicles to alternative investments such as real estate, works of art, precious metals, and more.
- Uniform Gifts to Minors Act (UGMA) accounts, which are limited to holding gifts of cash, stocks, mutual funds, and insurance policies.
In 2024, friends and family may contribute up to $18,000 free of gift tax to a child's UGMA/UTMA account. Couples can contribute up to $36,000.
529 Plans
529 plans, also known as qualified tuition plans, are tax-advantaged savings plans specifically set up to save for future education expenses. They are offered by states and vary somewhat depending upon the area you are in.
529 plans are divided into two categories: education savings plans and prepaid tuition plans. These accounts typically permit investment in mutual funds and exchange-traded funds, as well as some target-date funds, but not individual stocks.
Coverdell Education Savings Accounts
Coverdell education savings accounts function similarly to 529 plans, although they have strict contribution and income limits. The total contribution to any beneficiary may not exceed $2,000 per year.
Account holders with modified adjusted gross income (MAGI) of $110,000 or more and account holders who are married and filing jointly with MAGI of $220,000 or more are ineligible for these accounts.
Custodial Roth IRAs
A parent or guardian may assist a child who has begun to work and earn income in opening a custodial Roth IRA account. Both parent and child may contribute to these accounts, but there is a limit of $7,000 in total contributions per child per year for tax year 2024.
Choosing the Right Brokerage Firm
Well-known firms offering accounts for minors include Charles Schwab, Fidelity, E*TRADE, Merrill Edge, and Vanguard.
When selecting a brokerage firm, parents and guardians should look into prospective firms' histories and reputations. They should be aware of the different types of custodial accounts that each offers as well as each account's tax implications, contribution limits, and other restrictions.
Custodians also should consider their child's financial goals (both shorter-term and long-term) when considering which type of account to open.
For a particular account, different brokerage firms may offer different investment options and educational resources, as well as charge a variety of fees. So it is well worth the time to shop around.
Opening a Custodial Account
Follow these steps to open a custodial account for a minor.
1. Select a Brokerage and Account
Decide which brokerage firm and account type is right for your child's and your needs. Consider the investment time horizon. Keep in mind both your current financial situation as well as your goals for your child's financial future.
2. Input Personal and Funding Information
The process of opening the account is usually quick and completed entirely online. You'll need information including Social Security numbers for any account holders and the minor beneficiary, contact information, employment information, and the identifying information for one or more other accounts to use to fund the custodial account.
3. Fund the Account and Manage the Investments
With the account created, the final step is to fund the account so that there is money to invest. Then you must manage those investments over time as the account holder. Custodial accounts can typically be funded with cash, stocks, or mutual fund transfers.
Tax Considerations for Custodial Accounts
Investment income from assets in many custodial accounts can incur taxes at either the account holder's or the beneficiary's tax rate, depending on the account.
In some cases there are also tax implications for contributions made to a custodial account. These tax considerations vary significantly for different types of accounts, so it's essential to know what to expect before you open one.
UTMA and UGMA Accounts
For example, UTMA and UGMA accounts are taxable and have no contribution limit. The way that taxes are calculated for these accounts depends on the amount earned. This is an important consideration to keep in mind when planning how much to invest in any given year.
In 2024, for instance, the first $1,300 in annual earnings in these accounts is exempt from federal income tax, while the next $1,300 is taxed at the child's rate.
529 Plan
In the case of a 529, earnings are exempt from federal tax when used for qualified college expenses, although they may be subject to state taxes depending upon your location. Account holders may also face a gift tax consideration if they contribute more than $18,000 to a particular beneficiary in 2024.
Coverdell Account
Contributions to Coverdell accounts are not tax deductible. Distributions from these accounts to their beneficiaries are tax free, but only to the extent that those distributions do not exceed the beneficiary's qualified education expenses. After this point, distributions are taxable to the beneficiary.
Custodial Roth IRA
Like Roth IRAs for adult investors, custodial Roth IRA account contributions are not tax deductible. However, distributions taken in the future are not subject to taxes.
If you plan to invest a portion of your child's income in a custodial Roth IRA, be sure to keep in mind the tax implications at the time your child earns the income.
Teaching Children About Investing
One of the many advantages of a custodial account is that it provides parents the opportunity to show their children how investing works, to follow and monitor the returns on their investments, and to realize the benefits of compound interest and long-range financial planning.
You can even use the account as a way to educate a child about different types of investment vehicles, constructing a balanced asset mix for a portfolio, and other more advanced investment topics.
What Are the Benefits of Opening a Brokerage Account for a Child?
Custodial brokerage accounts for minors provide parents and guardians a way to begin building children's savings and to prepare for their financial futures, while overseeing investment activity until they reach the age of majority. Such accounts can also be a valuable tool for teaching children about investing.
How Do I Choose the Right Brokerage Firm for My Child's Account?
First, check out the reputations and longevity of firms and any problems they've had in the past. Next, consider the types of custodial accounts that they offer and whether they meet your needs. You'll also want to take a close look at the fees each firm charges as well as the educational resources and their investment and funding options.
What Documents Are Required to Open a Custodial Account?
Most custodial accounts can be opened in minutes online using personal information for the adult account holder and the minor beneficiary, such as Social Security numbers, contact information, and employment information when relevant. You'll also need to provide information about an account to link to the custodial account for funding purposes.
The Bottom Line
Custodial accounts provide an excellent way for parents to start securing their child's financial future while educating them about the importance of saving, planning, and investing.
These accounts allow adults to control and manage assets belonging to a child for investment purposes, with all control of an account passing to the beneficiary when they reach the age of majority.
Some of the most popular types of custodial accounts include custodial brokerage accounts, custodial Roth IRAs, UTMA and UGMA accounts, and 529 plans. Most can be opened quickly and online at major brokerage firms.