According to the American Psychological Association, 72 percent of Americans have said that they experienced financial stress in the past month. Finances can be difficult and frustrating to the point where you may not want to think about your finances at all.
Avoiding your finances might save you from the stress and anxiety you feel towards money, especially when it comes to your children’s future. Opening up a custodial account for your children, nieces, nephews, or loved ones’ children, can help ease your worries and help plan a better future for them.
In this article, we’ll go over what a custodial bank account is, how they work, and the pros and cons of a custodial bank account.
What is a custodial account?
A custodial bank account is an account that is set up for the beneficiary, who is often underage but administered by someone who might be taking care of that person. The person who looks over the bank account has an obligation to act in the beneficiary’s best interest.
Known as custodians, these people cannot make any decisions with themselves in mind. There cannot be any type of kickback or financial gain for the administrator, as that is not the purpose behind their role.
Most of the time, custodial accounts are used with investments in mind rather than as a savings account. In those situations, the administrator, or custodian, of the account will invest money on behalf of the beneficiaries.
However, it can also be a great option for people who feel a lot of anxiety about money and find finances to be really stressful. If that sounds like you, then a custodial bank account could be the key to resolving your financial anxieties!
How does a custodial account work?
Once a custodial account has been established, the administrator, or custodian, will decide how to invest the money or best use the money in the account. However, no matter what, their decisions have to be made with the beneficiary’s best interest in mind.
Whenever the beneficiary reaches legal age in their state, the custodial account will then become theirs. At this point, the beneficiary will take full control of all activity pertaining to the funds in their account.
If the minor were to die before they turned the state’s legal age, then the funds within their custodial account will become part of their estate. From there, legal proceedings will begin and the estate will be dispersed appropriately.
Two types of custodial accounts
There are two different types of custodial accounts available to minors. There’s the UTMA account and the UGMA account. Here’s how they differ!
Uniform Transfers to Minors Act (UTMA)
The Uniform Transfers to Minors Act provides a way for parents or guardians to deposit assets into an account on behalf of a child. Cash is considered an asset, but when it comes to a UTMA account, assets are more along the lines of real estate, art, patents, and royalties.
Cash can still be deposited into UTMA accounts, but if the guardian or the trustee wanted to pass down another type of asset, then the UTMA custodial account would be a great option. These make it possible to diversify the types of assets children receive.
Uniform Gift to Minors Act (UGMA)
The Uniform Gift to Minors Act provides a way for trustees, guardians, or parents to pass down assets like cash, bonds, stocks, and mutual funds to children. This type of account is typically limited to these kinds of items, making a UTMA account better in terms of diversification.
Additionally, a 529 plan is another option for underage beneficiaries. Check out this article to learn more about 529 plans and how they work!
Pros and cons of custodial accounts
If you want to open a custodial account but you don’t know how many accounts you should have at one time, you can read this article. While you’re at it, you should also familiarize yourself with the pros and the cons of custodial accounts.
This includes understanding how and why each of these accounts could benefit you and your loved ones. We’ll help you figure out if you have to choose between one of the two types of custodial accounts or if it makes sense to open one of each!
Pros
Estate planning
An irrevocable gift can lessen a trustee’s estate taxes. This doesn’t help the beneficiary aside from being the one who inherits property, but it does benefit the person depositing the gift into the custodial account.
Variety
Custodial bank accounts can hold any investment as long as it falls into the categories of the accepted types. If you want to gift more complicated types of investments, your ability to do so will depend on the financial institution that the account belongs to. This does not mean that it’s impossible, but variety will be considered on a case-by-case basis.
Cost savings
Custodial accounts are inexpensive to set up and even less expensive to maintain. This is a huge benefit because as the trustee, you won’t have to pay money in order to gift an asset to the minor. This is one of the main reasons why they are so popular.
Cons
College savings
If the idea of creating this type of account is with college in mind, then there are other ways to go about saving up for college that are far more beneficial in the long run. We recommend you look into a 529 plan instead. These are specifically designed for higher education purposes.
Tax-friendly
If you’re looking for a way to save money on taxes, then custodial accounts are not the way to go. They do include tax advantages, but there are no tax benefits of a custodial account. When you make a deposit, there aren’t any deductions involved. Once the child becomes of age and they take over the account, they will be 100% responsible for the payment of taxes on the assets in their account as well.
Irrevocable
Parents may have an idea of what they want for their children and they often spend years planning for their children’s future. But once the child reaches the legal age set forth by the state, then they can do whatever they want, both in life and with the contents of their custodial accounts. The moment the beneficiary is considered legal in their state, they’ll receive full control of the account, making everything the adults put into it irrevocable.
How do I get a custodial account?
Technology is making things easier and easier. As such, bank accounts can now be opened online without requiring you to step foot inside of your local branch. Custodial accounts can usually be opened online as well, though it depends on your bank or financial institution.
Parents, aunts, uncles, guardians, and family friends can open a custodial account on behalf of a minor. The terms of the custodial account will be set forth by the financial institution, including interest rates, minimum balances, and management fees.
Estate planning
Providing money or gifts to a loved one is a very generous thing to do. It will help to contribute to their estate and set them up for financial success. Start by deciding whether a UTMA account or a UGMA account is right for you.
Now that you’ve set up your loved ones with a financial future, consider diversifying your financial portfolio with our safety net feature and investment account. For only $1/ month, you can set up an auto-investing account. Choose how conservative or aggressive you’d like to invest, set your monthly contribution and we’ll handle the rest!
