What Is a Custodial Account?

Custodial accounts are financial accounts managed by one person on behalf of another. Typically, custodial accounts are held by parents to save money or invest for their minor children.

Opening a custodial account may help your child establish a sound financial future. However, if you are considering opening a custodial account, here are some things that you should consider.

What Is a Custodial Account?

Custodial accounts may be opened and maintained by any person for the benefit of a minor. Most custodial accounts are set up by a parent, grandparent, or other adult family member or guardian on behalf of a child under the state’s age of majority (the age of majority is 18 in most states but could be as old as 25).

With a custodial account, the custodian — the adult managing the account — has transacting authority over the account and can make deposits and withdrawals. Anyone can contribute to a custodial account. It’s possible to use a custodial account to gift minors cash, securities, annuities, real estate, and other kinds of assets.

How Do Custodial Accounts Work?

Custodial accounts function like other investment and savings accounts offered by banks and brokerages. The funds in custodial accounts may be used for any purpose that benefits the minor. This may include education expenses, as well as covering the costs of clothing, a first car, or practically anything else that may be deemed a benefit to the child.

Contributions to custodial accounts can be made in several ways, including depositing a paper check or cash at the bank or initiating a wire transfer. Many banks will even allow clients to set up a direct deposit account that regularly transfers a specific amount of money from an adult’s checking or savings account to a custodial account.

Although anyone may contribute to a custodial account, control of the account is managed by the custodian. Once the minor beneficiary reaches the age of majority (as determined by the state), the custodian can transfer the funds in the account over the funds to the minor.

Types of Custodial Accounts

There are two main types of custodial accounts: Uniform Transfer to Minor Act (UTMA) accounts and Uniform Gift to Minors Act (UGMA) accounts. Both were made possible by the U.S. laws by which these accounts are known. 

You can contribute nearly any type of asset to an UTMA account, including cash, securities (such as bonds, stocks, and mutual funds), annuities, insurance policies, real estate, works of art, and other items of value. PNC offers UTMA accounts that make contributing to a young loved one’s financial future easy. 

The Benefits of Custodial Accounts

Let’s examine some of the advantages of opening and contributing to a custodial account.

Ease of Use

Custodial accounts are a relatively easy and streamlined way to contribute to a child’s financial well-being. They may be conveniently opened by any adult at many financial institutions, including banks.

Their ease of use makes custodial accounts a popular alternative to trust funds--legal instruments typically created with the help of a lawyer. Custodial accounts may be used for any purpose as long as it’s for the benefit of the minor child. That can include school tuition, as well as fees for summer camp, a cell phone, a first car, a laptop computer, clothing, etc.

No Limits on Contributions

There are no limits on contributions made to a custodial account. Anyone can contribute any amount of assets in any given year. However, it’s worth noting that the federal gift tax may eventually apply to contributions (see the next section below).

Custodial Account Tax Advantages

In the U.S., the Internal Revenue Service (IRS) allows some tax advantages to custodial accounts. Because the minor child is legally the owner of the account, special tax rate rules apply.

In 2024, the first $1,250 in earnings in a UGMA or UTMA account — which are deemed “unearned” income — is typically exempt from federal income taxes. The following $1,250 may be taxed at the lower “kiddie tax” rate of 10%. 

If the unearned income of a custodial account exceeds $2,500, it will be taxed at a different rate and may be subject to an additional net investment income tax (NIIT) of 3.8%.

Once the minor reaches the age of majority —18 or 21, depending on the state in the minor’s state of resident — they can file their own tax return, with earnings in the account subject to their tax bracket.^[1]

In addition, in 2024, any single contributor can contribute assets worth up to $18,000 to a custodial account without triggering the federal gift tax.^[2]

The Disadvantages of Custodial Accounts

Of course, custodial accounts have some drawbacks that should be considered in the decision-making process.

A Potential Negative Impact on Financial Aid

Because custodial accounts are assets that are legally considered the property of the minor beneficiary, they may reduce the child’s eligibility for financial aid when it comes time for college. The Free Application for Federal Student Aid (FAFSA) determines how much financial aid for which a student may be eligible and assumes that 20% of the applicant’s assets will be used toward tuition in any one academic year. As a result, assets kept in a custodial account may limit how much financial aid the student can obtain.^[3[

Inability to Switch Beneficiaries

Once a custodial account has been set up, it’s impossible to change the beneficiary on the account. Custodians can’t name a new beneficiary for the account.

Alternatives to a UGMA or UTMA Custodial Account for a Minor

If the disadvantages of a custodial account outweigh its benefits in your particular situation, here are alternatives worth exploring:

• Joint savings accounts: A joint savings account can be an alternative to using a custodial account. These accounts allow multiple holders. It's a convenient way for more than one person to manage money in the same account.
• Kid-friendly accounts: Some banks offer accounts specifically for children. For example, PNC offers a kid-friendly account called S is for Savings®. This account offers features that help kids learn about smart spending and savings habits. As children reach their teen years, they can switch to a student-centric account such as PNC’s Virtual Wallet Student® account, a combined savings and checking account.
• Coverdell ESAs: A Coverdell education savings account (ESA) is often categorized alongside the UGMA or UTMA account as a type of custodial account. They also come with tax advantages — the beneficiary can receive distributions from the account tax-free. However, unlike the custodial accounts discussed above, ESAs may be used solely for educational expenses. There are also other limits to ESAs such as contribution limits dependent on the contributor’s adjusted gross income. In 2024, single taxpayers earning $95,000 or less and married taxpayers earning $190,000 or less are limited to $2,000 in contributions.^[4]
• 529 plans: Named after Section 529 of the U.S. Revenue Code, 529s savings plans are tax-advantaged plans intended to help pay for a child’s education. As with ESAs, withdrawals are tax-free when used for qualified education-related purposes. Some 529 plans allow owners to lock in tuition rates and services as prepaid tuition plans. 529 plans are run by all 50 states, as well as the District of Columbia. Rules and fees may vary by state.
• Trust funds: Trusts are legal agreements created with the help of a lawyer as part of the estate-planning process. With many trusts, a trustee must be appointed to manage the account on behalf of the grantor. Typically, the trustee receives a fee for fulfilling this role, potentially making them a more expensive option than a custodial account.

The Bottom Line on What Is a Custodial Account

A custodial account, or UGMA or UTMA account, is a financial tool that can be used to save and invest in a child’s future. They provide flexibility in how the funds can be spent.

However, as with all financial matters, whether or not a custodial account is right for you depends on your unique situation. Carefully review the pros and cons before deciding if one of these accounts is the right choice for you.