Ask the Experts: How does an UGMA/UTMA custodial account work?
An UGMA/UTMA custodial account is a special type of account that allows a minor child to legally hold money or other property, such as stock or real estate, that the child would not otherwise be able to hold in his or her own name. It’s governed by a particular state’s Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). Most states have enacted an UTMA because it allows for more types of property to be held in the account, and the account can remain open longer than with an UGMA.
A custodial account can easily be opened at a bank or other financial institution using a common form. Central to the operation of a custodial account is the custodian, who is responsible for contributing money or property to the account, managing these assets, and withdrawing from the account when necessary. Typically, the custodian is the parent, but it’s possible for another person or even a bank (for a fee) to act as the custodian.
Custodial accounts have several unique features. Any money or property placed in the account is considered an irrevocable gift to the child. (Gifts qualify for the federal annual gift tax exclusion, which means you can gift $12,000 per year to the account without incurring gift tax.) Withdrawals from the account can only be made for the child’s benefit.
Any income earned by assets in the account is taxed to the child under the “kiddie tax” rules–for children under age 18, the first $850 of investment income is tax exempt, the next $850 of investment income is taxed at the child’s rate (usually 10%), and anything over $1,700 is taxed at the parent’s rate. For children 18 and older, the first $850 of investment income is tax exempt, and anything over $850 is taxed at the child’s rate.
When the child reaches the relevant age (generally 21 or 25 for UTMA accounts, and 18 for UGMA accounts) the custodianship ends and the child receives sole control of all the assets in the account.