Jan 5, 2019
Custodial accounts allow parents, relatives or any adult to open an investing account for someone under 18.
Where adults get to have their own accounts, kids get to have accounts so long as they are controlled by an adult, known as custodians in this case. The child, known as the beneficiary on the account, is the one that benefits from the account, whether the funds are withdrawn before they are 18 or after.
Custodial accounts are great because they can be setup easily, they provide flexibility to invest in many different ways while letting you use the money how you see fit, so long as it is benefitting the child.
The adult remains in control of the account until age 18 or 21 depending on the state, when they can then access it, should they request it.
You can make withdrawals at any time so long as it is used for the child’s benefit.
You can invest however you'd like with cusotodial accounts, so you can put it in a set and forget fund, or you can choose different companies, index and thematic funds to invest into. If your child is ready, you can even do it together with them, to learn about the world from the eyes of an investor.
Kids are lucky to receive a tax-break on their first $1,050 of annual unearned income and their next $1,050 of unearned income is taxed at a very low tax rate - around 10%.
If you contribute more than $15,000 per year, or $30,000 as a married couple, you'll likely trigger the Gift Tax. This can be avoided by staying within these limits but you can read the IRS rules to get all the details.
The adult on the account, who is the custodian, is the manager and controller of the account until the child reaches adulthood - which differs depending on their specific state. Assets that are contributed into the child's custodial account are immediately and irrevocably transferred.
Even though the adult can withdraw from the child's account at any time before they're adults, they must only use it towards things that benefit the child. Once the child reaches adulthood, they have the freedom to withdraw it and use it as they like. Hopefully by that point, they may even decide to keep it invested for the long term.