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Maggie Overfelt

How to Save Money for Your Child With a Custodial Account

It’s a smart move to set aside money for baby’s future—and a custodial account can help you do that. Here’s what you need to know about opening a custodial savings account.

We all want the best for our kids—so when it comes to planning for baby’s financial future, parents are eager to set aside money for their children to access down the line. Many parents opt to open a simple savings account to stash all the monetary birthday gifts that will trickle in through the years. And there’s nothing wrong with that—there’s no risk of losing the money, and your bank probably pays a little bit of interest over time. But what if you could possibly grow your child’s money over the next decade or so?

A custodial account, which allows parents to invest their kids’ cash in mutual funds, stocks, bonds and exchange-traded funds (ETFs), can be a way to increase the money over time and see returns on your balance. Here’s everything you need to know about setting up a custodial account for baby.

In this article:
What is a custodial account?
Custodial account benefits
Custodial account rules
Optimizing your custodial account

What Is a Custodial Account?

Simply put, a custodial account is a savings vehicle accessible through a financial institution or brokerage firm that adults control for minors under the ages of 18 to 21, depending on state laws. Parents (aka the custodians) are in charge of all transactions. While the amount of money required to open a custodial account can be minimal— Stash, a financial services company in New York, allows users to start off with just $5—the fees associated with having one vary depending on who you’re banking with.

There are two types of custodial accounts: UGMAs (Uniform Gifts to Minors Act) and UTMAs (Uniform Transfers to Minors Act), and different states generally allow one or the other. UTMA rules enable parents to invest in a bigger pool of assets, including real estate, while a UGMA account restricts itself to more traditional securities (this means no high-risk investments like stock options or buying on margin).

Custodial Account Benefits

The biggest advantages of custodial savings accounts revolve around accessibility. Anyone—whether it’s a parent, grandparent, aunt or other—can open a custodial account; that person can then contribute to it without any limits on the amount they put in. They can choose to invest the cash in whatever investment assets their bank offers. “A custodial account offers a lot more flexibility, and you’re kicking off your child’s financial future in an amazing way,” says Lindsay Goldwert, editorial director at Stash Invest. The biggest pro: Once your child becomes of age, she takes it over and can use the money however they wish. Unlike with a 529 tuition plan, where young adults are penalized with crazy fees if they use the money for things other than education-related expenses, the money in a custodial account can be used for anything: school, rent, a downpayment on a house, a wedding and so on.

Custodial Account Rules

To open a custodial account, all you need is basic information about your child: name, birthday and social security number. Once it’s set up, you manage all the action in the account, which revolves around deposits and deciding which assets to invest in. You can also make cash withdrawals at any time, but the money must be used on behalf of your kid. Keep in mind that there may be fees involved with getting out of certain assets, and any capital gains on liquidated funds are subject to taxes.

When it comes to taxes and custodial accounts, know that any deposit over $15,000 initiates the federal gift tax. Children who file taxes on their parents’ return are allowed a certain amount of unearned income at a reduced rate. The first $1,050 isn’t taxed annually. The next $1,050 gets taxed at the child’s bracket—about 10 percent—and anything over that is taxed at your (the parents’) rate.

It’s worth noting that because custodial accounts are considered assets, they could hurt your child’s eligibility to receive financial aid when the times comes to apply for college.

Optimizing Your Custodial Account

Opening a custodial account for your child will most likely entail dealing with stocks or stock-like funds, such as ETFs. If you’re at all skittish about exposing your child’s money to the bit of risk that dabbling in the market requires, remember history shows that for the long-term, investing in stocks and mutual funds is a much more lucrative way to earn interest than what a basic savings account will return. You’ll have to find the right balance between your desire to make money and your tolerance for losing it—something Stash might be able to help with.

“We have a certain selection of curated stocks as possible investments for our customers,” Goldwert says, emphasizing the company’s mantra of long-term investing and diversification, meaning putting your money into a bunch of different assets at once. “We want to give people the opportunity to own these stocks in amazing companies they see every day.”

Stash charges $1 a month for its custodial accounts—you don’t have to pay per trade like you do with some brokerages—and half that for any new accounts for subsequent children. Accounts with a balance of $5,000 and over are 0.25 percent a month. Once you’ve funded your account, you invest just like you would in any other investment account.

While Stash won’t connect you to a human financial advisor for investment advice—its service revolves around its app, which is completely automated and optimized to showcase things like your earnings and dividend reports on demand— Stash Academy offers an array of financial literature that teaches kids (and you) about the basic tenets of personal finance and investing 101.

The company is hoping parents will use its custodial accounts not only to grow money for their kids, but also as a financial learning tool. “You’re never locked in to just one basket—you can add other stocks if, say, your child doesn’t like Nike anymore,” Goldwert says. “If your child is interested in a robotics company, you can add a robotic ETF. We want the child’s interests to be reflected over time; we want the account to grow with them.”

Published November 2018

Disclosure: This post contains affiliate links, some of which may be sponsored by paying vendors. XO Group Inc. and its affiliates do not provide tax, legal, financial, accounting or similar advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, financial, accounting or similar advice. You should consult your own advisers before engaging in any transaction.

Plus, more from The Bump:

How to Save for Baby’s Future Education with a 529 Plan

How to Prepare Your Finances for Baby’s Arrival

How to Write a Will to Protect Baby’s Future