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Resources > Education Center > Custodial Bank Accounts for Minors—Types, Benefits, and Key Considerations

Custodial Bank Accounts for Minors—Types, Benefits, and Key Considerations

As a parent, you know how unpredictable life can be. The economic landscape might change significantly by the time your child grows up, and a savings fund can be their buffer for countering such uncertainty and enjoying a more stable adulthood.

Custodial bank accounts for minors are an excellent way to invest in your child’s bright future. If you’re considering opening such an account, there’s a lot you should know before making any commitments. This guide will help make a decision by explaining:

  • How custodial accounts work
  • What to consider before opening the account
  • What other ways there are to support your child’s future

What Is a Custodial Bank Account for Minor Children?

Technically speaking, a custodial bank account is any account opened by a fiduciary—a person in charge of the account—on behalf of the beneficiary who owns but doesn’t control the assets. A parent or legal guardian can open a custodial account for their child and manage it until they come of age.

When you open the account, you can place funds in it or invest in various assets, such as:

  • Stocks
  • Bonds 
  • Mutual funds
  • Securities

All assets you put into the account are considered irrevocable gifts belonging to the minor, though they can’t access them until they come of age. The age of account takeover doesn’t need to be the same as the state-defined legal age (typically 18)—the child might not get access to the account until they’re 25 in some states. When they do, you no longer have control over the account, and your child gets unrestricted access to it.

Reasons To Have a Custodial Bank Account for a Child

A custodial account is used to save for your child’s future, which you can do in many ways. The most common is making cash contributions, but you can also invest in different assets to build significant wealth for them.

Another good reason to open a custodial account is if your child inherits a significant sum of money or any other assets. You can restrict access to the funds until they are mature enough to use them responsibly.

Finally, a custodial account is an excellent way to teach your child to invest without the risk of your child making foolish investment decisions. They can’t make executive decisions or control assets until adulthood, which is enough time to teach them how to manage their wealth.

How To Open a Custodial Bank Account for Minors

You can set up a custodial account with many banks, brokerages, and other financial institutions. The process is fast and straightforward—all you need to do is schedule a meeting and provide basic information on your child, such as their name, birth date, and Social Security number (SSN).

Even though the process is simple, opening a custodial account is a big decision. Before you go through with it, you must assess the following:

  1. Available account types
  2. Tax implications

Types of Custodial Bank Accounts for Minors

When talking about custodial accounts, people typically refer to two types named after the act that governs them:

  1. UGMA (Uniform Gifts to Minors Act)
  2. UTMA (Uniform Transfers to Minors Act)

Both account types serve the same purpose, though they vary in the assets you can hold. A UTMA account supports a wider variety of assets, including less common ones like art or intellectual property. 

Another notable difference is the account takeover age. While UGMA accounts are typically transferred to children when they reach the state-defined legal age, a UTMA account might be in the parent’s control for an extended time (until the child turns 25, as mentioned earlier in this guide).

Besides the two main types, there are several other options for custodial accounts you can choose from, depending on your goals:

AccountMain Purpose
Custodial Roth IRASaving for retirement through tax-advantaged contributions
Custodial 529Saving for college and qualified education expenses
Coverdell Education Savings AccountSaving for qualified K-12 and college expenses

Unlike these accounts, UTMA and UGMA don’t have a specific intention, so your child is allowed to spend the funds as they please after taking over.

Tax Implications of Custodial Accounts

Source: Nataliya Vaitkevich

Until your child assumes independent responsibility for the custodial account, you’re in charge of all applicable taxes. While taxes can vary, you should pay special attention to two universal implications:

  1. The gift tax
  2. The kiddie tax

As mentioned, all contributions to a custodial account are considered irrevocable gifts to your child, so they’re subject to the gift tax. The good news is that there are exclusions—for 2023, up to $17,000 are tax-exempt, and your spouse can gift the same amount. If both parents participate in the account, the total limit for 2023 is $34,000.

Note that the exclusion typically changes annually, so make sure to check it for the ongoing tax year when you open the account.

The kiddie tax was imposed by the IRS to prevent tax avoidance through gifts. If your child’s custodial account generates an income—which it most likely will—it’s subject to the kiddie tax.

Unearned income from the custodial account is taxed as follows:

  1. First $1,250—tax-exempt
  2. The next $1,250—taxed at the child’s rate
  3. $2,500 and over—taxed at the parent’s rate

If your child has unearned income generated by the account, you can use Form 8615 to file the appropriate taxes. Much like the gift tax, exemptions and thresholds may differ depending on the tax year.

Want To Give Your Child a Head Start in Life? Help Them Build a Strong Credit Profile

Even if you build significant wealth for your child, you never know when they might need access to credit. To kick-start their relationship with lenders and make many life milestones easier, you should help your child start and build a solid credit profile.

Without your help, they likely won’t get their first credit score before 21 because the CARD Act of 2009 made it hard for anyone younger to obtain credit cards. Other financial products are equally inaccessible to young adults with no credit.

The conventional approach some parents opt for is adding children to their credit cards, which lets the child inherit the parent’s score. This method is flawed for several reasons:

  • The parent’s credit activity impacts the child’s profile, so any red flags will show up on both reports
  • The parent must give the child full access to their credit card, which can lead to significant debt without proper financial education
  • The child piggybacks on their parent’s credit profile instead of building their own—all credit activity related to the parent’s card is deleted from the child’s profile when they’re removed from the card

If you want to avoid these limitations and help your child build a strong credit profile, FreeKick is a much better solution.

How FreeKick Helps Your Child Build Credit

FreeKick is offered by Austin Capital Bank, a Federal Deposit Insurance Corporation-insured (FDIC-insured) bank. It combines an FDIC-insured deposit account with credit building and protection services to help you build and monitor your child’s credit profile.

Even without contributions to a custodial account, parents are typically swamped with subscriptions and ongoing expenses. This is why FreeKick offers a FREE plan with a one-time FDIC-insured deposit and two tiers with small annual fees:

Deposit AmountPlan

With FreeKick, you don’t need to put any extra work into your child’s credit profile—all you have to do is:

  1. Make a Deposit—Sign up at FreeKick.bank and choose your plan
  2. Set It and Forget It—When the account is active, your child will automatically start building 12 months of credit history
  3. Keep Growing—When the 12-month cycle ends, you can sign up for another 12 months or cancel the account and receive 100% of your deposit back

As your child builds a payment history, FreeKick will report it to the three major consumer credit bureaus if they’re a legal adult. If they’re a minor, reporting will be activated when they reach legal age (18 in most states), as the bureaus only accept credit reporting for adults. 

You can close the account at any point without penalties! Keep in mind that if you do it before your child becomes a legal adult, no reporting can ever be done for the account.

Safeguard Your Child’s Identity With FreeKick’s Comprehensive Monitoring

Identity fraud affects one in 50 U.S. children annually. Fraudsters target minors because their SSNs are unmonitored and randomized (as of 2011), so they can be combined with fake information for a spoof identity. This is known as synthetic identity fraud, and it is far more difficult to detect than identity theft.

Using a child’s SSN, a fraudster can steal money from financial institutions, as explained in this diagram from the Federal Reserve’s whitepaper on synthetic identity fraud:

Source: The Federal Reserve: Detecting Synthetic Identity Fraud in the U.S. Payment System

Despite their best efforts, parents typically can’t prevent this issue beyond checking and freezing their child’s credit report. This approach is limited and ineffective, so FreeKick offers credit profile monitoring to proactively detect signs of identity fraud.

To make your child a reliable borrower and reduce the risk of identity fraud, sign up for FreeKick.

Featured image source: nattanan23