A custodial account is an investment account that can be established for the benefit of a minor. It is somewhat similar to a trust but easier to establish. The custodian is the adult that manages the assets on behalf of the child.
Brokerages such as Charles Schwab, TD Ameritrade, Vanguard, Fidelity, E-Trade, and others offer these accounts. There are essentially three different types of custodial accounts that are widely utilized, and we will take a look at them in this post.
The Uniform Gifts to Minors Act (UGMA) was established in 1956, and this is one of the options that is available to you. If you establish a UGMA account, you can act as the custodian or you can name someone that you know personally to assume the role.
Another possibility is a professional fiduciary. Trust companies and the trust departments of banks provide custodian services, and this can be the right choice for some people. As a fiduciary, the custodian is legally required to act in the best interests of the minor beneficiary.
The investments that can be made with assets that have been conveyed into a UGMA account are limited to securities like stocks and bonds and insurance policies. There are no contribution limits, and multiple different people can make contributions into a UGMA account.
These contributions are made after taxes have been paid on the income, so there is no further taxation on distributions of the principal. The first $1050 in taxable distributions of the earnings can be received tax-free, and the second $1050 will be taxed at the child’s rate.
A UGMA account will continue to grow until the child reaches the age of 18. At that time, the account must be terminated. The assets can be used by the beneficiary for any purpose, and they can also be transferred into a different type of account.
There are no contribution limits, and this is another positive. However, distributions are looked upon as income that is earned by the child, so they would be counted if the child applies for financial aid.
In 1986, the National Conference of Commissioners on Uniform State Laws recommended the utilization of the standards set forth in the Uniform Transfers to Minors Act (UTMA). These accounts work in the same manner as UGMA accounts with one significant difference.
As we have stated, the investment choices for UGMA accounts are limited to securities and insurance policies along with cash. You can convey any type of property into a UTMA account.
Another difference is the age of majority and trust termination. For UTMA accounts, the age is 18 in the state of California.
Section 529 Savings Plans
With both of the other types of custodial accounts that we have looked at, the assets in the account can be used for any reason once the child reaches the age of majority. On the other hand, assets in a Section 529 savings plan must be used for school expenses.
You contribute after-tax income into these accounts, and distributions that are used to cover qualified educational expenses are not taxed. This applies to the principal and the earnings.
Mutual funds are the primary investment vehicles that are used by Section 529 plans. When it comes to the financial implications, just 5.64 percent of the value of the account can be counted against the applicant, so these accounts are beneficial on that level as well.
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