Can I Close a Custodial Account and When?

Custodial accounts, established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), serve as a structured method for adults to hold and manage financial assets for a minor beneficiary. These accounts facilitate gifting and investment for a child’s future, allowing assets to grow over time. Understanding the specific rules governing these accounts, particularly when they terminate and how assets are transferred, is important for both custodians and beneficiaries.

Understanding Custodial Accounts

A custodial account is a legal arrangement allowing a minor to own assets managed by an adult custodian. The assets are irrevocably gifted to the minor beneficiary and cannot be reclaimed by the donor.

The custodian holds a fiduciary duty to manage the account prudently and solely for the minor’s benefit. This includes making investment decisions and overseeing distributions. Funds must be used for the minor’s benefit, such as education or healthcare, and cannot be used for the custodian’s personal expenses or for items the custodian is legally obligated to provide.

The beneficiary does not have direct control over the assets until reaching a specified age. The custodian manages the assets until the beneficiary can assume full control.

When Custodial Accounts Terminate

Custodial accounts are not typically “closed” at the custodian’s discretion before the beneficiary reaches a certain age. Instead, these accounts formally terminate when the minor beneficiary reaches the “age of majority” as defined by state law. This age varies by state, commonly 18 or 21, though some states permit the custodianship to extend to age 25 if specified during establishment. Upon reaching this age, the assets must be transferred directly to the now-adult beneficiary.

Termination signifies the beneficiary’s full legal control over the assets. This transfer is mandated by the account’s structure, irrespective of the custodian’s opinion regarding the beneficiary’s financial maturity. While the age of majority is the most common trigger, other events can also lead to termination.

One such event is the death of the beneficiary before reaching the age of majority. In this scenario, the assets become part of the beneficiary’s estate and are distributed according to their will or state inheritance laws. The death or resignation of the custodian does not terminate the account itself, but requires the appointment of a successor custodian to continue managing the assets until the beneficiary reaches the age of majority.

Process for Account Termination

When the beneficiary reaches the age of majority, the adult beneficiary or custodian contacts the financial institution to initiate the transfer of assets. The institution will require documentation to verify the beneficiary’s identity and age, such as a government-issued identification or birth certificate.

The next step involves completing the financial institution’s required forms, often called a Transfer/Registration Change Request. These forms authorize the transfer of assets out of the custodial account.

Beneficiaries have options for receiving the assets. They can choose to have securities transferred “in kind” to a new personal brokerage account, or request a cash distribution where assets are sold and proceeds are transferred to their bank account. The beneficiary will need to open a personal investment or bank account to receive these funds.

The entire process, from submitting documentation to asset transfer, can take a few days to several weeks, depending on the financial institution and the complexity of the assets involved.

Financial and Tax Considerations

The termination of a custodial account and the subsequent transfer of assets to the beneficiary generally do not constitute a taxable event. The transfer merely shifts control from the custodian to the adult owner without triggering new income or gift taxes. However, income and capital gains generated by the assets within the account are subject to specific tax rules throughout the account’s life.

Unearned income, such as interest, dividends, and capital gains, generated by custodial account assets is taxed to the minor. The “Kiddie Tax” rules apply to this unearned income above certain thresholds. For 2024, the first $1,300 of a child’s unearned income is generally tax-free. The next $1,300 is taxed at the child’s own tax rate. Any unearned income exceeding $2,600 is taxed at the parents’ marginal tax rate. These rules apply to children under age 18, or under age 24 if they are full-time students and do not provide more than half of their own support.

If appreciated assets were sold by the custodian before the account terminated, any capital gains would have been taxed under the minor’s Social Security number, subject to the Kiddie Tax rules. If the assets are transferred in kind to the adult beneficiary and then sold, the capital gains tax liability falls on the adult beneficiary at their individual tax rate, with the original cost basis carrying over from the custodial account. Custodial accounts can also impact eligibility for need-based financial aid for higher education. These accounts are considered assets of the student and are assessed at a higher rate by financial aid formulas, often reducing aid eligibility by 20% to 25% of the asset’s value, compared to parental assets. Upon receiving full control, the adult beneficiary assumes responsibility for managing investments and reporting future income and gains on their personal tax returns.