Can a Grandparent Open a Custodial Account for Their Grandchild?

Saving for a grandchild’s future is a meaningful way to provide financial support, and custodial accounts offer a straightforward option. These accounts allow assets to be managed on behalf of a minor until they reach adulthood, making them popular for education savings or general financial gifts.

Understanding how these accounts work, including who can open them, tax implications, and eventual ownership transfer, is important before getting started.

Who Is Eligible to Open It

Grandparents can open custodial accounts for their grandchildren under the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). These laws allow any adult—grandparents, parents, or other relatives—to establish an account for a minor. The account is in the child’s name, but a designated custodian manages it until the child reaches adulthood, typically at 18 or 21, depending on state law.

Some financial institutions require a parent to serve as custodian, particularly brokerage firms and banks with policies aimed at simplifying account management. Checking with the institution beforehand ensures compliance with their requirements.

If a custodial account is already established by a parent, grandparents can contribute without being the custodian. Contributions may qualify for the annual gift tax exclusion, which is $18,000 per recipient in 2024.

Required Documentation

Opening a custodial account requires verifying the minor’s identity and the custodian’s authority. Financial institutions typically ask for the child’s Social Security number or Individual Taxpayer Identification Number (ITIN) for tax reporting. A birth certificate may be required, particularly if the custodian is not a parent.

The custodian must provide a government-issued photo ID and Social Security number. If their address differs from the minor’s, proof of residency, such as a utility bill or bank statement, may be needed. Some institutions request an employer identification number (EIN) if the account is expected to generate significant income, though this is less common.

Account agreements outline the custodian’s responsibilities, including investment authority, withdrawal restrictions, and the process for transferring control when the minor reaches adulthood. Reviewing these terms ensures compliance with state laws and institutional policies.

Funding Options

Custodial accounts can be funded through direct cash transfers, checks, or electronic bank transfers. Many financial institutions offer recurring contributions, allowing automatic monthly deposits.

Beyond cash, these accounts can hold stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Some brokerage firms allow fractional share purchases, making it easier to invest in high-value stocks.

Gifted securities are another option. Grandparents can transfer existing investments to the custodial account, potentially reducing capital gains tax liability. If stock with appreciated value is transferred, the child assumes the original cost basis, which may result in lower taxes if sold while the child is in a lower tax bracket. However, under IRS rules, unearned income above $2,600 in 2024 may be taxed at the parent’s marginal rate.

Control of Assets

The custodian manages the account and makes investment decisions, but all funds must be used for the child’s benefit. Funds cannot be used for personal expenses, and misuse can result in legal consequences.

Most financial institutions allow custodians to adjust investment portfolios without requiring approval from the minor or other family members. Some institutions, however, restrict high-risk investments like margin trading or options contracts.

If a grandparent serving as custodian wants to step down due to age or health concerns, state laws allow for custodian replacement. This typically requires a court petition or a formal designation of a successor. Failing to transfer custodianship properly can create complications, especially if the original custodian becomes incapacitated without naming a successor.

Tax Reporting

Custodial accounts have tax implications for both the minor and the custodian. While the assets belong to the child, any income—such as interest, dividends, or capital gains—is taxable. The IRS applies the “kiddie tax” to unearned income, which can impact tax liability.

For 2024, the first $1,300 of unearned income is tax-free, the next $1,300 is taxed at the child’s rate, and any amount above $2,600 is taxed at the parent’s marginal rate. This rule prevents families from shifting large amounts of income to children to take advantage of lower tax brackets. If a custodial account generates significant investment income, IRS Form 8615 may be required.

If a grandparent contributes appreciated assets, the child assumes the original cost basis, which determines capital gains taxes when sold. Long-term gains are taxed at lower rates, while short-term gains—on assets held for less than a year—are taxed as ordinary income. Unlike 529 plans, custodial accounts do not offer tax-deferred growth, meaning taxes on earnings must be paid annually. Strategic tax planning, such as timing asset sales or investing in tax-efficient funds, can help reduce tax burdens.

Transfer of Ownership

When the minor reaches adulthood—typically 18 or 21, depending on state law—control of the custodial account transfers to them. At this point, the custodian no longer has authority over the assets.

Unlike 529 plans, which are designated for education expenses, custodial accounts do not impose spending restrictions. Once the transfer is complete, the recipient can use the funds as they choose. Families concerned about financial responsibility may consider alternatives like trusts or education-specific accounts. Early financial education can help prepare the child for managing their assets responsibly.