What Type of Account Will Most Likely Be Established for a Minor?

Saving for a child’s financial future is a common goal, whether for educational expenses, a financial foundation, or instilling financial responsibility. Various account types exist to facilitate these objectives, each with distinct features and benefits. Understanding these options helps in selecting the most suitable vehicle for a minor’s financial growth, considering implications for control, taxation, and ultimate use.

Custodial Accounts

Custodial accounts, primarily established under the Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA), serve as common tools for gifting assets to minors. These accounts are set up by an adult, known as the custodian, who manages the assets on behalf of the minor beneficiary until they reach the age of majority. While the custodian controls the account, the assets legally belong to the minor, creating an irrevocable gift.

The distinction between UGMA and UTMA accounts centers on the types of assets they can hold. UGMA accounts are limited to financial assets like cash, stocks, bonds, and mutual funds. UTMA accounts offer broader flexibility, allowing for a wider range of assets, including real estate, intellectual property, artwork, and other tangible property, in addition to financial assets. Most states have adopted both UGMA and UTMA.

These accounts are subject to specific tax implications, notably the “kiddie tax.” This tax applies to a portion of the minor’s unearned income, such as interest, dividends, and capital gains generated within the account. For 2025, the first $1,350 of a child’s unearned income is tax-free. The next $1,350 is taxed at the child’s marginal tax rate. Any unearned income exceeding $2,700 for 2025 is taxed at the higher rates applicable to trusts and estates, which can be comparable to the parent’s tax rate.

A significant characteristic of custodial accounts is the transfer of control to the minor upon reaching the age of majority, which varies by state, typically between 18 and 21, and in some cases up to 25. Once the minor reaches this age, they gain full legal control over the assets and can use them for any purpose, without restriction from the former custodian. This lack of control over how the funds are spent after transfer is a consideration for those establishing these accounts.

Education Savings Accounts

For individuals focused specifically on saving for educational expenses, dedicated accounts offer tax advantages. The two primary options are 529 plans and Coverdell Education Savings Accounts (ESAs), each structured to support future education costs with unique benefits.

529 plans are tax-advantaged savings plans designed for educational expenses. They come in two main types: college savings plans and prepaid tuition plans. College savings plans allow contributions to grow tax-deferred, and withdrawals are tax-free when used for qualified education expenses. These qualified expenses include tuition, fees, books, supplies, equipment, and room and board at eligible educational institutions.

Since 2019, 529 plans can also be used for up to $10,000 annually per beneficiary for K-12 tuition. As of July 4, 2025, additional K-12 expenses like curricular materials, tutoring, and testing fees are also qualified. There are no income limits for contributors, and while no annual contribution limit exists, large contributions may be subject to gift tax considerations.

Coverdell ESAs also provide tax-advantaged savings for education but differ from 529 plans in several ways. Contributions to Coverdell ESAs are limited to $2,000 per beneficiary per year, and contributions are not tax-deductible. These accounts have income limitations for contributors; for instance, in 2025, the ability to contribute is gradually reduced for single filers with modified adjusted gross income (MAGI) between $95,000 and $110,000, and for those filing jointly between $190,000 and $220,000. Coverdell ESAs offer broader flexibility for qualified education expenses, encompassing K-12 tuition, books, supplies, tutoring, and computers, in addition to higher education costs. Funds from a Coverdell ESA must be used by the time the beneficiary reaches age 30, or remaining earnings may be subject to taxes and penalties.

Retirement Accounts for Minors

While most retirement accounts are geared toward adults, a Roth IRA can be a valuable savings tool for minors, offering long-term tax benefits. The primary requirement for a minor to contribute to a Roth IRA is that they must have earned income. Earned income refers to taxable wages, salaries, tips, or net earnings from self-employment, such as income from a W-2 job, babysitting, or lawn mowing. Gifts or allowances not compensation for work performed do not qualify as earned income.

The annual contribution limit for a Roth IRA for a minor is the lesser of their earned income for the year or the federal limit, which is $7,000 for 2024 and 2025. Contributions are made with after-tax dollars, meaning they are not tax-deductible.

A Roth IRA provides tax-free growth, and qualified withdrawals in retirement are also tax-free. This can result in considerable tax savings over many decades.

An advantage for minors is the flexibility regarding early withdrawals of contributions. Contributions to a Roth IRA can be withdrawn at any time, tax-free and penalty-free, as the money has already been taxed. This flexibility allows the minor to access their contributions for other purposes, such as higher education expenses or a first-time home purchase (up to $10,000 in earnings), without penalty. However, earnings withdrawals require the account to be open for five years and the owner to be at least 59½ years old to be tax-free and penalty-free.