Custodial Account: Planning for a Child’s Future

A child’s very first account is likely a custodial account established at a bank, brokerage firm or with a mutual fund company. The goal is to provide for life milestones of the minor such as college or homeownership. Although the Unified Transfer to Minors Act (“UTMA”) provides an inexpensive and expedient arrangement for accumulating wealth on behalf of a minor, there are some drawbacks.

Custodial Account Drawbacks

These accounts are used to hold assets until the minor attains the age of majority in accordance with the State’s rules. In New York, the minor is legally entitled to 100% of the proceeds upon attaining the age of twenty-one (21), unless the donor specifically stipulates age eighteen (18) as the age of majority. Even at age 21, most parents do not trust their children’s decisions to invest or spend the funds prudently.

Once a gift is made to a UTMA account, the account is irrevocable. The funds deposited to the account cannot be returned to the donor who transferred the monies in. However, the custodian has full discretion to utilize the funds in the account for the use and benefit of the minor without a court order.

Financial Aid Concerns

As to tax analysis, custodial accounts are considered an asset of the child and are counted against financial aid. If a minor’s interest income plus dividends total more than $1,900 in one year, then the account will also be subject to the “Kiddie Tax”. A portion of the minor’s UTMA interest income will be taxed at the tax rate of his or her parents or legal guardian instead of the lower tax bracket that the child would have been in.

A Living Trust

A better approach that would eliminate the investment and spending uncertainty of a 21-year-old, is to create an inter-vivos (living) trust for the minor that holds the monies one would otherwise gift to a UTMA account. The trust could have as many beneficiaries as the grantor (donor) desires and provisions as to the use of the trust principal and/or income for the benefit of the minor that is tailored in accordance with the wishes of the grantor creating the trust.

Most importantly, the trust could continue until the minor attains a specified, perhaps more mature age (i.e., 35) or even for the life of the person.