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Little girl hugging her dadCustodial accounts allow you to manage finances for a child or other minor. Usually these types of accounts are set up by a parent, relative or guardian on behalf of a family member, although this isn’t necessary. Any adult can set up a custodial account on behalf of any child, such as a friend or even a stranger, unless otherwise restricted. Custodial accounts can be an excellent vehicle for assets such as college accounts, safety nets and trusts. Once you’ve set up such an account, a financial advisor can help you pick securities to put in the account that match the beneficiary’s needs.

What Is a Custodial Account?

A custodial account is an account or investment portfolio that adults can set up on behalf of a legal minor (someone under 18 years of age).

Technically you can use any account as a custodial account by simply earmarking the money. If you want to set aside a bank account or a specific portfolio for your child, nothing stops you from doing so. In addition there are several types of specific accounts which allow parents and guardians to save for their children’s future. The most common of these is the 529 college savings plan.

A custodial account is something different from a mere earmark, though. It is a formal, legally protected, account that keeps assets for the minor beneficiary. In many ways it is similar to a trust in this regard. There are two types of custodial accounts: UGMA accounts and UTMA accounts (named after the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act, respectively). The most significant difference is that a UGMA account can only hold financial assets such as cash, stocks and other securities. Meanwhile a UTMA account can hold most assets of value, such as real estate and personal property.

Once a transfer has been completed to either a UGMA or a UTMA account, it cannot be freely withdrawn. The adult who sets up the account can manage it and make investments, but except for specific circumstances they can only use the account’s assets for the benefit of the child beneficiary. This is the main benefit of using a custodial account, along with certain benefits related to gift taxes.

Good Custodial Accounts

Young black man in collegeMany banks and investment firms offer custodial accounts. Finding one is, first and foremost, a decision of comfort level. Especially if the recipient child is young, you are going to have this relationship for a long time. Pick an institution you feel comfortable banking with for the foreseeable future. Beyond that, look for a firm that can offer the right balance of fees and guidance. Again, the longevity of this account is the key here.

On the one hand, this account may last a decade or more. High fees will have the time to seriously eat into this money. On the other hand, over time you will probably want guidance on how to invest for changing circumstances, maximize tax advantages and otherwise make the most of this (likely significant) portfolio.

Sound financial advice can pay for itself many times over. With these factors in mind, you can start looking at some excellent accounts, including but not limited to the following.

  • Vanguard – Low fees, good longevity planning with its portfolio of mutual funds

We’re starting to sound like a broken record here, but the central theme of most custodial accounts is time. This is an account which you will likely need for years to come, meaning that you need to plan and invest for up to 18 years.

With its outstanding selection of mutual funds, and its low fees for both trading and maintenance, Vanguard is a terrific option for this type of investing. You can use a Vanguard custodial account to build a portfolio designed around long-term assets for investing over the long haul.

  • Acorns – Innovative, low-touch investing for the long term

Acorns has a very clever business model. This is a robo-advisory, meaning that they manage your money for you based on a series of preferences you select. While you can invest money directly, they also allow you to integrate their system into your banking and daily spending. Whenever you make a transaction, Acorns will round it up to the nearest dollar. The difference is then shuffled off into your Acorns portfolio to be invested and managed by their algorithms.

This is investing done five cents, 14 cents, 67 cents at a time. While it won’t add up to much right away, if you open a custodial account for an infant they will receive that money in 18 years. That’s more than enough time, as the company says in its marketing material, for an acorn to grow into a tree.

  • Ally – Good for banking

Ally has a great pitch for its custodial accounts: They charge no monthly maintenance fees and offer interest rates up to 0.5%. They also require no monthly minimum balances, but this should not be a concern if you are opening a custodial account.

This makes Ally an excellent choice for custodial banking. Your money won’t get nibbled to death by fees, and you might even have the time to get a tidy (if still small) return off the interest rate.

Bank of America is a runner up when it comes to custodial banking. They charge no fees for any account with more than $500, which again should not be a concern. If you are not transferring significant wealth over time there is no good reason to set up a custodial account.

While Bank of America’s interest rates are a fraction of Ally’s at 0.1%, they offset this with institutional size and access. You don’t know where your child will be in 18 years, nor what specific financial needs they might have. By setting up their custodial account with Bank of America, you can likely ensure that they will have both financial access and advice once they take control of their money.

Mother and daughterOne of the other important things to consider about a custodial account is how the child will use his money after he takes control of it. Ideally the child will not simply clean out the account, but instead will continue to manage and maximize the value of this investment. This is where Charles Schwab comes in particularly handy. Schwab offers outstanding, low-fee investment options while you manage this account during your child’s minor years. Once they turn 18, the firm also offers a wealth of financial advising services to help them understand the responsibilities and opportunities that come with that kind of money. A custodial account with Charles Schwab offers you great tools for investment. It offers your beneficiary the same advantage.

The Bottom Line

Custodial accounts are a good tool for passing wealth on to a child. While there are better vehicles for specific goals such as college tuition, if you would like to simply ensure the transfer of assets a UGMA or a UTMA account can keep that property safe until the child reaches the age of majority.

Investing Tips

  • You want to make sure that when you hand off money to your sons or daughters they have the best financial guidance possible. After all, 18 years old is very young to come into the kind of money a custodial account usually holds. A financial advisor can provide the best possible guidance. Finding one doesn’t have to be hard. SmartAsset’s matching tool can help you locate a financial advisor in your area to start building those relationships now, for when you need them later. It only takes a few minutes. If you’re ready, get started now.

Photo credit: ©iStock.com/martin-dm, ©iStock.com/DMEPhotography, ©iStock.com/demaerre

Eric Reed Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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