How a Custodial Account Could Help You Invest for a Child’s Future

What is a Custodial Account?

A custodial account is an investment account you can open for a minor under either the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). Unlike other college savings options, custodial accounts don't have restrictions on what the money may be used for, as long as it benefits the child.

Key Features:

• Ownership: The assets legally belong to the child.
• Control: The custodian (typically a parent but can be anyone) manages the account until the child reaches the age of majority (usually 18 or 21, depending on the state).
• Flexibility: Funds may be used for a wide range of purposes, not just education.

Types of Custodial Accounts: UGMA vs. UTMA

How Does a Custodial Account Work?

1. Opening the Account:

• Typically requires the child’s Social Security number.
• The custodian makes decisions and handles transactions.

2. Making Contributions:

• There are no annual contribution limits, but gifts may be subject to the federal gift tax if they exceed annual thresholds.
• For 2025, the annual tax exclusion is $19,000 per donor per beneficiary.¹

3. Managing the Money:

• You may invest in stocks, bonds, mutual funds, or other permitted securities.
• The child cannot access or control the account until they reach the majority age.

4. Transferring Control:

• At 18 or 21 (depending on the state), the child gains full control of the account, even if they don’t plan to use it right away.

What Are the Tax Rules for Custodial Accounts?

Custodial accounts can offer tax benefits, but only up to a certain point. While they allow investments to potentially grow over time, earnings are typically taxed as unearned income and may be subject to both regular tax rules and additional layers of taxation depending on the child’s age, income, and filing status.

You may want to consult a qualified tax professional for guidance tailored to your specific situation, as tax treatment can vary based on individual circumstances and evolving IRS rules.

Kiddie Tax

• First $1,350: Tax-free
• Next $1,350: Taxed at the child’s rate
• Amounts above $2,700: Taxed at the parent’s rate (as of 2025 thresholds; subject to change)²

Capital Gains Tax:

• Profits made from selling stocks, mutual funds, or other assets in the account may be subject to capital gains tax.
• If the asset is held for one year or less, it’s considered a short-term capital gain and is typically taxed at ordinary income rates, which range from 10% to 37% in 2025, depending on the child's total income, or the parent's rate if the kiddie tax applies.
• If the asset is held for more than one year, it’s a long-term capital gain and may be taxed at 0%, 15%, or 20%, based on the child's (or parent's) taxable income.³
• These gains count as unearned income and are included when determining whether the child’s total income exceeds the $2,700 kiddie tax threshold in 2025.

Annual Gift Tax

• Under IRS rules, each individual may gift up to $19,000 in 2025 per recipient without triggering federal gift tax or filing requirements
• For married couples, gifts may be "split," allowing up to $38,000 total per recipient in 2025, tax-free and without filing Form 709
• Gifts exceeding the limit must be reported on Form 709, and count against your lifetime estate and gift tax exemption ($13.99 million per individual in 2025)⁴

Benefits & Limitations of Custodial Accounts

When Might a Custodial Account Make Sense?

A custodial account may make sense if your primary goal is to provide long-term financial support or investment access to a child. They often have fewer restrictions on how the money is eventually used. People often use custodial accounts to gift money, stocks, or other assets to minors. They keep control and protect the assets during childhood.

You may want to consider a custodial account if:

• You plan to contribute regularly, whether through a one-time deposit or an ongoing payment strategy, to build funds for college, life milestones, or general support.
• You’d like flexibility in how the money may be used, rather than locking it into one purpose. For example, the account could potentially help pay for a student’s car, summer program, or housing, not just tuition.
• You’re comfortable with transferring control once the child reaches the age of majority, even if that means they’ll be able to use the money at their discretion.
• You’re investing in equities or other market-based assets for a long time, and you want to manage those investments on the child’s behalf while helping build toward their financial futures.

Considerations Before Opening a Custodial Account

Before setting up a custodial account, it may help to clarify what you're trying to accomplish. Is your primary goal saving for college, making gifts, or gradually building assets over time? While these accounts may offer flexibility, they also involve permanent transfers of ownership and may carry certain tradeoffs.

Think about:

• Your long-term goals: Think about whether the contributions are meant solely for college or intended to support a broader range of future needs. Custodial accounts may help cover a variety of expenses, including travel, housing, or general support in early adulthood. Clarifying your goals may help you choose the most flexible option.
• The child’s future control: Are you comfortable with the child gaining full control of the account at the age of majority (typically 18 or 21)? Once you transfer the money, the child makes payment decisions. This is true even if the money was meant for education or other uses.
• Impact on financial aid: Assets in a custodial account are generally considered the student’s property, which can have a greater impact on financial aid eligibility compared to parent-owned accounts. Since student assets are assessed at a higher rate in financial aid formulas, this may potentially reduce the amount of aid the student qualifies for.
• Account administration: Consider any service or maintenance fees, particularly for low-balance accounts or those held at brokerage firms. Some providers charge account-level fees based on total assets, transaction frequency, or account activity. These costs may reduce your returns over time, so it’s worth reviewing a provider’s fee schedule in advance.
• Flexibility vs. oversight: While custodial accounts generally offer more flexibility than other more education-specific plans, they come with fewer restrictions on how the deposits are used once the child gains control. This flexibility can help or limit you. It depends on how you feel about giving up decision control.

Alternatives to Custodial Accounts for College Savings

If your primary goal is to save for education expenses, there are other account types that may offer more targeted tax advantages and longer-term control. If you're unsure how to align your account choice with your broader financial goals, a tax or legal professional may be able to provide guidance tailored to your situation.

529 Plans

A 529 plan is designed specifically to help families save for qualified education expenses, including tuition, books, and certain room and board costs. Earnings grow without tax until withdrawn, and withdrawals are usually tax-free when used for qualified education costs. These plans often allow higher contributions than custodial accounts. The account holder keeps control even after the student becomes an adult.

Coverdell Education Savings Accounts (ESAs)

Coverdell ESAs also offer tax-deferred growth and tax-free withdrawals for qualified K–12 and college expenses. Coverdell ESAs have a $2,000 yearly limit per child. Funds must be used or moved to another eligible person by age 30, unlike 529 plans.⁵ They may offer more investment flexibility, but contribution limits and income rules can make them less available for some families.

Final Thoughts: Take the Next Step

A custodial account isn’t just a way to hold money, it’s a step toward giving a child greater financial opportunity and responsibility. Thinking through how, when, and why you contribute can shape how that opportunity unfolds. As with any long-term decision, it may help to revisit your goals over time and adjust your approach as circumstances change.

   See how a UGMA or UTMA custodial account may support your child's future ambitions. Invest In My Child's Future  

Sources

1. Internal Revenue Service. "Gifts & Inheritances 1." https://www.irs.gov/faqs/interest-dividends-other-types-of-income/gifts-inheritances/gifts-inheritances-1
2. Fidelity. "What to know about the kiddie tax." https://www.fidelity.com/learning-center/personal-finance/kiddie-tax
3. Buy Side from Wall Street Journal. "What Are Capital Gains Taxes?" https://www.wsj.com/buyside/personal-finance/taxes/capital-gains-tax?
4. American Council of Aging. "Giving or Receiving Gifts and the Impact on Medicaid Eligibility: Understanding the IRS’ Gift Tax Exclusion." https://www.medicaidplanningassistance.org/gift-tax-exemption/
5. Internal Revenue Service. "Topic no. 310, Coverdell education savings accounts." https://www.irs.gov/taxtopics/tc310
6. Fabric by Gerber. "UGMA investment accounts for kids." https://meetfabric.com/ugma-investment-account-for-kids?