What Is a Custodial Account? Types, Rules, and Taxes

A custodial account is a financial vehicle established by an adult to hold and manage assets for a minor. This type of account allows for the transfer of wealth to a child while delaying their direct control over the funds. The assets are legally owned by the minor, but all management and transaction decisions are made by the adult until the child reaches a legally specified age.

Key Roles and Responsibilities

A custodial account involves two primary parties: the custodian and the minor beneficiary. The custodian, typically a parent, grandparent, or other adult, is the individual who opens and manages the account. The minor, or beneficiary, is the child for whom the account is established. Only one custodian and one beneficiary can be named per account.

The custodian’s role is governed by a strict legal standard known as fiduciary duty. This requires the custodian to act prudently and solely in the best financial interests of the beneficiary. All transactions, from investment decisions to withdrawals, must be for the exclusive benefit of the child. The custodian is prohibited from using account funds for their own personal expenses or to satisfy their ordinary parental support obligations, such as basic food, housing, and clothing.

Types of Custodial Accounts

There are two main types of custodial accounts, established under state laws: the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). The UGMA was the original framework to transfer financial assets to a minor without a formal trust. UGMA accounts are generally restricted to holding purely financial assets, such as cash, stocks, bonds, mutual funds, and insurance policies.

The UTMA is a more modern and flexible version of the UGMA that has been adopted by most states. It expands upon the types of property that can be held in a custodial account. In addition to the financial instruments allowed in a UGMA, an UTMA account can hold virtually any type of property. This includes physical assets like real estate, fine art, patents, and royalties, offering a much broader range of gifting options.

Contribution and Withdrawal Rules

Contributions to a custodial account are irrevocable gifts, meaning the transfer is permanent and cannot be reversed. Anyone, including parents, grandparents, other relatives, and friends, can contribute funds to the account. There are no limits on the total amount that can be contributed.

Withdrawals from the account are governed by the rule that they must be for the use and benefit of the minor. This provides flexibility for expenditures that enrich the child’s life beyond basic necessities. Legitimate uses could include paying for summer camp, a personal computer for school, specialized tutoring, or saving for future college expenses. The custodian must keep records and ensure all distributions directly serve the child’s interests.

Tax Considerations

The earnings within a custodial account, such as interest, dividends, and capital gains, are taxable and reported under the minor’s Social Security number. This unearned income is subject to special regulations often called the “kiddie tax.” For 2025, the first $1,350 of unearned income is tax-free, the next $1,350 is taxed at the child’s own, typically lower, tax rate. Any unearned income exceeding $2,700 for the year is taxed at the parents’ higher marginal tax rate.

When making contributions, donors should be aware of federal gift tax rules. For 2025, an individual can give up to $19,000 to any single person, including a minor’s custodial account, without any tax consequences or filing requirements. A married couple can combine their exclusions to gift up to $38,000. If a donor contributes more than the annual exclusion amount in a single year, they may be required to file a gift tax return (Form 709), though tax is not usually owed unless the donor’s lifetime gift exemption is exceeded.

Transfer of Assets to the Beneficiary

The custodian’s control over the account is temporary and ends when the beneficiary reaches the age of termination, also known as the age of majority. This age is determined by the laws of the state where the account was established and is typically 18 or 21.

Once the beneficiary takes control, they can use the funds for any purpose they choose, without limitation or the need for approval from the former custodian. Because the assets in a custodial account are legally owned by the child, they are reported as a student asset on the Free Application for Federal Student Aid (FAFSA). This can significantly reduce eligibility for need-based college financial aid, as student assets are assessed at a much higher rate than parental assets.