For parents looking to help their children financially, custodial accounts provide the child a gift for the future while parents save on taxes today.
Custodial accounts are held in the name of a minor but are legally managed by an adult, typically a parent or grandparent. Deposits can be made into the account, interest is earned, and the custodian retains control until the child reaches the age of majority.
The advantage for parents is that special tax rules apply, allowing up to $1,000 in earnings per year to go untaxed and a second $1,000 to be taxed at the child’s rate. Only earnings above $2,000 will find their way onto the parent’s tax return.
Among the most common custodial accounts are savings and CD accounts at a bank or credit union. With these, parents can make a lump-sum gift or periodic deposits and the principal will accrue interest modestly but with almost risk-free safety.
Opening such an account is not much more difficult than opening one for yourself, and almost all banks and credit unions offer them. Just note that you’ll need to provide personal information and a social security number for both the child and the custodian.
You’ll also need to decide whether to open an UGMA (Uniform Gift to Minors Act) account or an UTMA (Uniform Transfer to Minors Act). UGMAs can hold deposit and brokerage assets and generally transfer to the child at age 18. UTMAs, meanwhile, can also hold assets such as real estate and typically remain custodial until age 21.
As always, shopping for a top rate is smart when opening a custodial savings or CD account. Once you’ve chosen a financial institution, their representatives can answer your questions on the age of majority in your state and which account will suit your child best.