Setting up an account for a child, grandchild or other minor in hopes of helping them save for the future is a noble goal. But not all accounts are equal.
Custodial brokerage accounts – in which the adult acts as “custodian” for the child until they reach legal adulthood – have been a common way to do this. The accounts are easy enough to set up: You register an account in the child’s name at a bank or a brokerage, under either the Uniform Gift to Minors Act or Uniform Transfers to Minors Act.
The main difference between the two is that a UGMA account can only hold direct financial instruments like stocks, bonds or cash, while a UTMA account can hold other properties such as real estate.
There are some differences in the technicalities of both types of trust, based on which state you live it and the legal age of adulthood in that state. But overall, they are a simple way to transfer assets to a minor. There usually aren’t any contribution limits, unlike limitations when funding an IRA to kids as a gift. What’s more, the money doesn’t have to be earmarked for anything in particular, such as education expenses.
But there are some things you need to be aware of if you’re wondering whether to set up a custodial brokerage account for a child.
Beware of the drawbacks of custodial brokerage accounts
There was a time when a custodial brokerage account offered an appealing tax benefit, but that is not always the case anymore. In fact, there can sometimes be considerable tax implications. Here are some things to keep in mind:
- You may have to file tax returns for the child. The account belongs to the child, not to you. But as custodian, you are responsible for filing taxes if the income on the account exceeds $1,150. The next $1,150 would be taxed at a favorable rate but after $2,200, the money gets taxed at a higher rate (potentially up to 37%), thanks to what’s known as the “kiddie tax.”
- You may have to file gift tax returns. Individual contributions into a custodial brokerage account more than $15,000 in 2021 ($16,000 in 2022) can potentially result in federal gift tax liability (married couples can contribute $30,000). There are exemptions in place that can make having to pay a gift tax unlikely, but you would still have to file even more forms.
- The money’s not yours anymore. Another important thing to remember is that you don’t own the assets, and you won’t have control anymore once the child reaches the legal age (most often 18 or 21, depending on the type of account and the state you live in). When you’re in charge, if any money is taken out of the account, it can only be used for the child’s direct benefit. But when the young person legally takes control of the money, they can do whatever they like with it. So, it’s important to think about whether you may need to access that account you funded in an emergency but can’t, and whether you are willing to let an 18- or 21-year-old make the decision about when and how to spend the money.
- It could hurt your chances of getting financial aid. If you’ve set up a custodial brokerage account for a college fund, it may make you less likely to be granted federal financial aid because the assets belong to the child.
For more ways on how you can help your children save for their future, contact an Edelman Financial Engines planner.
Neither Edelman Financial Engines, a division of Financial Engines Advisors L.L.C., nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances.