Pros and Cons of Custodial Accounts
The Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) both provide methods by which to give gifts of money or other funds to children, whether they are your own, your nieces and nephews, your grandchildren, or other children with whom you have a close relationship. An adult "custodian" chosen by the giver manages the accounts until the child reaches the age of majority. Custodial accounts in some way resemble trusts. The following chart summarizes the major advantages and disadvantages of custodial accounts.
PROS
- The UGMA and UTMA provide convenient, uncomplicated ways to give gifts and otherwise transfer money, stocks, and bonds to minors.
- The giver designates himself, herself, or another responsible adult to be the custodian of the account, which means that he or she will manage the money for the minor until the minor reaches maturity and make withdrawals from the account as deemed appropriate.
- Custodial accounts can be used to fund a child's education.
- A UGMA or UTMA custodial account can be used like a trust in order to give nontaxable gifts of money during your lifetime, up to a certain limit, thereby avoiding both gift taxes and estate taxes on the amounts given.
- The income from a custodial account is charged to the child. If the child is paying taxes at a lower rate than the parent, this can result in further tax savings.
- Custodial accounts are much simpler to establish than trusts, which have more complicated legal requirements and can be more costly.
CONS
- Once you transfer money into a custodial account, you
can't take it back, even with the child's consent.
- The money in the account is automatically turned over to
the "child" once he or she becomes twenty-one, or sooner in some
states, regardless of the recipient's maturity. With a trust, the trustee can designate that the beneficiary receive the funds as late as age twenty-five.
- The existence of the account can cause a reduction in the
amount of financial aid that is available to the child when he or she attends college. Assets held in a child's name weigh more heavily against financial aid eligibility than do the parents' assets.
- If the custodian dies before the account terminates, it is
included in his or her estate, so the money in the account could end up subject to estate tax in that manner.
- If a parent uses income from the account to satisfy his or
her legal obligation to support a child, the income becomes taxable to the parent, since parents have a legal obligation to support their children.
- The UTMA does not allow for you to designate what happens
to the money in the account if the child it dies before receiving the money. Under a trust you are allowed to make this determination.
