A Parent’s Guide to Custodial Brokerage Accounts
Custodial accounts are accounts for minors (generally those less than 18 years old) set up by parents, guardians, and other adults. Custodial accounts are important because they are the only way for minors to enter into any financial transactions (such as opening bank accounts or brokerage/investment account for kids).
A parent/guardian or any adult that opens the account has control of it until the child is 18-25 years old at which time the assets belong to the adult for whom it was established.
In this article, we begin by describing custodial accounts in general and then discuss custodial brokerage accounts which can be used to teach your kids about investments. We also show the top 10 custodial accounts.
Incidentally, many parents use custodial brokerage accounts as a way to teach their kids how to invest in the stock market. If you’d like to know how your kids can easily learn to invest in stocks and exchange-traded funds, go to the TeenVestor Stocks Certification Course or click on the image above.
Gifts to Minors Through Custodial Accounts
In the United States, the ability to transfer money to minors while in the process of setting up custodial accounts is achieved through the use of state legislation: the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA).
Difference Between the UTMA & UGMA Accounts
These two types of accounts are very similar in nearly all respects. The most significant differences between the two are: 1) the breadth of assets that can be included in the accounts and 2) the date at which control of the account passes to a child.
While both the UGMA and the UTMA accounts allow for the inclusion of stocks, mutual funds, exchange-traded funds, and other financial assets, the UTMA account additionally allows for things like real estate and art, and other assets.
The adult who establishes a UGMA account loses control of the account once the child reaches his age of majority – 18 or 21, depending upon the state. By contrast, the adult who establishes a UTMA account is permitted to postpone the transfer of control of the account to a child, depending upon the state, until he is 25.
Whether a UGMA or UTMA account is used depends on the law of the state in which you establish the account. Typically, transfers of money or assets made to a UGMA or UTMA account are irrevocable and belong to the child in whose name the account is registered.
Who Establishes the Custodial Account?
A custodial account is established by an adult who is considered the custodian of the account. The minor for whom the account is established is considered the beneficiary of the account.
In the eyes of the law, the assets in the account belong to the minor and are held in his name. The child, however, can’t get his hands on the account’s assets until he reaches the age of majority – 18 years old in some states and 21 in others, although there is an option to delay transfer to age 25.
The custodian who establishes the account – typically a parent, grandparent, or other relatives – has management responsibility for the account. In other words, the custodian must be involved in all financial transactions in the account, even though the assets in the account belong to the minor.
Restrictions on How to Use the Money in the Account
Regardless of whether you establish a UTMA or a UGMA account (depending on your state), these accounts have very strict rules that prevent custodians from using them as their personal piggybanks.
Furthermore, while you can withdraw money from the account for your child’s benefit, the assets in a UGMA account can’t be used to pay for things that you are legally obligated to provide to support your child (such as food, clothing, etc.).
However, UTMA accounts are more liberal than UGMAs in that they permit funds in the account to be spent for the support of the child.
No Limit to Contributions by Parents, Grandparents, and Other Adults
There is no limit to how much money can be transferred to minors through custodial accounts. Cash gifts can be transferred to a custodial account without adverse tax consequences for you, your relatives, and the beneficiary.
Under current tax laws, gifts of less than $15,000 (or less than $30,00 for joint contributions) each year are not subject to a gift tax and thus, neither the gift giver nor the recipient is required to pay taxes on the gifts. This is known as the “gift tax exclusion.”
The only condition is that the recipients of the gifts must have what’s called a “present interest” in the gifts. In other words, the gifts must be wholly and completely available to the beneficiary (your child) as soon as they are actually given.
Please consult a tax expert or a financial advisor for advice on general tax consequences on establishing and contributing to custodial accounts.
Custodial Brokerage or Investment Accounts
A custodial brokerage account (sometimes called a custodial investment account) is a type of custodial account through which your minor can make investments under your direct supervision.
These accounts are easy to establish and you can open them for investing in stocks, mutual funds, direct stock investment plans, and other assets. Some parents even use these accounts to save for college expenses for their children.
You will have no decision to make in terms of choosing a UGMA or UTMA account when it comes to opening a custodial brokerage account. The company with which you are establishing the custodial brokerage account will tell you what type of account category (UTMA, UGMA, or both) is available in your state.
Choosing an Online Broker that Offers Custodial Brokerage Accounts
To open a custodial brokerage account to help your kids start investing, you first have to choose an online broker that allows affordable custodial accounts suitable for teens.
Remember that while your kids can make suggestions about what assets such as stocks to buy for a custodial brokerage account, you are ultimately responsible for making the investments.
The things you have to look for when searching for an online broker include:
No stock trading fees – you should find online brokers that charge $0 to buy and sell stocks.
Low balance stock trading accounts – make sure the online broker does not require you to maintain a sizeable minimum balance in a trading account; there are many that offer $0 minimum balance.
Brokers that allow for fractional shares – if you want to invest as little as $1 in reputable companies with high stock prices, you can only do so if the online broker allows you to buy fractions of a share of stock.
Low to no monthly fees for signing up or for maintaining your account.
Top Ten Custodial Brokerage Accounts
Here is a short list of the top 10 affordable custodial brokerage accounts brokers that are best for very young investors. I've linked directly to each company's custodial account section. For a detailed description of each of these online brokers, go here: Detailed Explanation of Each Online Broker.
You can see that some of the companies on the list above (line items 1 to 5 above) are traditional online brokers that have been around for a long time. The other companies (line items 6 to 10) are newer online brokers specifically formed to cater to parents with minors or young investors. Some of these newer companies (especially Greelightcard, Loved Investing), specifically market their apps to parents who want to help their kids learn about investing in the stock market.
Information You Need to Open Custodial Brokerage Accounts
Opening a custodial brokerage account is very simple. The basic information you will need to open up such an account includes the following:
The contact information, birth date, and Social Security number of your child.
Your driver's license number (if you have one).
Your Social Security Number.
Your employer's name and address (if applicable).
Bank information so you can move money into the custodial brokerage account if necessary.
What are the Advantages of Custodial Brokerage Accounts?
The main benefits of a custodial brokerage or investment account established for your child revolve around the following:
Convenience. Unlike other options like trusts, custodial accounts do not require extensive paperwork or a lawyer's input. Adults can open custodial savings accounts or custodial brokerage accounts at any bank or other financial institution with minimal effort, provided they accept the terms offered.
Taxes. You can contribute up to $15,000, and your spouse can contribute the same amount to the account and obtain a federal gift and estate tax exemption. (More on taxes here).
Withdrawal rules. You can make a penalty-free withdrawal from your child’s custodial brokerage account to pay for your child's expenses, including school tuition, extracurricular activities, braces, computers, and other school supplies.
Variety. Depending on the type you select, you can open a custodial stock account or any other kind of investment account for kids with stocks, bonds, or property.
Earnings. Custodial brokerage account investment income of less than $1,100 is considered your child's income and not taxable by the Internal Revenue Service. (More on taxes here).
Irrevocable. Notwithstanding a qualifying expense, once you establish a custodial account, only your child can remove its assets upon reaching legal adulthood. As a result, nothing can derail your savings plan for your child's financial future.
Options. Unlike other financial vehicles, such as college 529 plans or trusts, custodial accounts do not restrict how adult children use them.
What Are the Disadvantages of Custodial Brokerage Accounts?
A custodial brokerage account can give your child a head start on the path to long-term financial security. Still, along with the upsides, consider the downsides before deciding if this financial planning option will meet your family's goals.
Tuition Roadblock. Although you can make deposits into a custodial account, the funds do not belong to you; they belong to your child. As a result, your child’s college financial aid may be reduced due to the amount of money he has in the custodial brokerage account.
Taxes. The gift amount you contribute to a custodial account is not tax-deductible. Also, if your contribution exceeds $15,000 in a year, you must file IRS Form 709 to track your lifetime gift contributions, even though you do not pay taxes on your annual gift.
Withdrawal rules. Before you place assets into a custodial account, you must be sure you will not need them to pay for other expenses. You cannot withdraw funds for anything other than your child's needs.
Earnings. Annual custodial brokerage account investment income exceeding $2,200 is subject to something called the “Kiddie Tax” — a tax rate equivalent to your tax rate. This is to prevent parents from using custodial brokerage account to lower their tax rates. (More on taxes here).
Irrevocable. Your child gains sole control over custodial account funds upon reaching legal adulthood and can use them for any purpose, regardless of your preferences. Therefore, if you disagree with your child's decisions, you cannot reassign the account's ownership or reclaim its contents.
After Opening a Custodial Brokerage Account for Your Kids, then What?
Establishing custodial accounts for your kids is great but what's next? We suggest that you introduce them to stock investing right away!
Why stocks? Because the investments that are likely to make the most money for your kids over the long term are probably the ones related to stocks – either individual stocks or broad market index-based exchange-traded funds.
Giving Your Kids the Means to Invest
There is no point in lecturing your kids about investing unless you can give them the means to do so. . That’s why we feel that if you can afford it, you should seed a custodial brokerage account with a few hundred dollars so your kids can try their hands at investing.
Don’t forget the role relatives can play in helping you put some money in custodial brokerage accounts for kids. You kids may receive money from grandparents, aunts, and uncles for birthdays, holidays, graduations, and other special occasions and milestones. You may want to have these relatives earmark some of the funds for depositing into custodial brokerage accounts for investing in stocks, mutual funds, and other financial assets.
Practicing With a Dummy Stock Portfolio
But what if you don’t have enough money to seed a custodial stock account for your young investor? One thing you can do is to encourage them to practice buying and selling stock using a dummy stock trading portfolio.
Setting up a dummy stock trading portfolio (also called a mock or virtual portfolio) is one way young investors can overcome the fear of taking that first step in investing. Using fake dollars and virtual stock market simulators that pull stock prices from the real market, young investors can get a taste of the ups and downs of the stock market.
There are a few sites that allow anyone to set up dummy portfolios through stock market games in which he or she can compete with friends to see who has the highest profits in hypothetical portfolios they create with fake dollars. The sites tally up the daily portfolio values and rank them by usernames.
Some of the dummy trading portfolio portals we are familiar with are as follows:
MarketWatch Virtual Stock Exchange
TD Bank’s Virtual Stock Market
Your kids don’t have to participate in any games if they choose not to do so — they can just use the sites to just monitor their own dummy trading portfolios.
Online Stock Courses
After opening a custodial investment account but before seeding the account with cash, you should consider having your kids take a stock investment course. There are many courses offered on the Internet to teach stock investing. You can find them at sites like Udemy, LinkedIn Learning, Coursera, and many others.
However, you will not find any that are specifically designed for teens and that is comprehensive enough to give young investors the basic skills they need to begin investing in stocks. Many of these courses, even the beginner courses, are too advanced for very young investors.
Some online brokers have developed programs on their sites to teach basic investment concepts but once again, these are inadequate mainly because they are too advance for kid investors.
An excellent program for teaching kids stock investing is the TeenVestor Stock Certification Course. Designed for kids ages 13, this self-paced course uses text, video and audio lessons to teach the basics of stock investing.