What Is a Custodial Account and How Does It Work?
Written by
Caitlyn Moorhead
Edited by
Emily Gadd
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A custodial account is a financial account set up by an adult for a minor, typically to save or invest money for their future. The adult, known as the custodian, manages the account until the child reaches a certain age, usually 18 or 21, depending on the state.
Types of Custodial Accounts
You can open two types of custodial accounts: deposit accounts or investment accounts.
| Account Type | Pros | Cons |
|---|---|---|
| Savings Account | Low-risk, stable, easy-to-access funds | Limited growth potential, low interest rates |
| Investment Account | – Higher potential for long-term growth – No contribution limits |
-Subject to market risk, the potential of loss of principal – Cannot be shielded by tax liabilities, like a 529 plan |
Deposit Accounts
Custodial deposit accounts are simple savings accounts that allow parents or guardians to deposit money for a beneficiary, which can be their own child, an independent, or a minor relative. The funds in these accounts earn interest over time, but because the money earns simple interest, the returns can be minimal.
Though yields are on the low end, this makes the account a better option for short-term saving goals and immediate needs since there’s not as much risk that the account will lose value.
Investment Accounts
On the other hand, custodial investment accounts allow the money to grow much faster by investing in stocks, bonds or mutual funds. While these accounts have the potential for greater returns, they also carry a higher level of risk due to changes in the market.
How Taxes Work with Custodial Accounts
Taxes on custodial accounts depend on how much income the account generates ( and who pays those taxes. Here’s a breakdown of how it works:
Though the parent or guardian manages the account, the money legally belongs to the child. Any income earned by the account, such as interest, dividends or capital gains, is taxed under the child’s name. However, specific tax rules apply based on the amount earned:
- If the account earns up to a certain amount (e.g., $1,350 for the 2025 tax year), no taxes are owed because it falls under the child’s standard deduction.
- If income is between $1,350 and $2,700, it’s taxed at the child’s tax rate, which is generally lower than an adult’s.
- If income exceeds $2,700, the “kiddie tax” rule kicks in, and anything above this threshold is taxed at the custodian’s marginal tax rate.
The “kiddie tax” can also be a downside for families with high earners managing large accounts, as they may face higher tax rates on significant income generated.
How to Open a Custodial Account
No matter the type of custodial account you open, have your child set financial goals These goals could be things like saving to buy something they want, such as toys, clothes or even real estate. You can also ask them to set aside a certain amount to help with college, or something else in the future to give them a sense of short-term savings goals versus long-term savings goals.
Here are seven steps to follow to open a custodial account:
- Step 1: Gather the required documentation
- Step 2: Choose an account type
- Step 3: Find the best option
- Step 4: Apply for the account
- Step 5: Activate the debit card
- Step 6: Download the app
- Step 7: Fund it
Custodial Account vs. Other Accounts for Minors
Custodial accounts are generally regular deposit accounts, which are easier to set up and are managed by an adult on behalf of a minor until they reach adulthood.
On the other hand, trust funds involve a legal arrangement and often require a lawyer to create, making them more complex and geared toward larger sums of money or specific conditions.
Custodial Accounts vs. Joint Accounts
Custodial accounts allow account funds to be used for the minor’s benefit, but the adult managing it has complete control until the child becomes an adult.
Joint accounts are shared between an adult and a minor. Though the minor has shared access with this account, there’s no clear transfer of ownership at a set age like a custodial account.
How Custodial Accounts Compare to 529 College Savings Plans
Custodial accounts can be used for anything related to the child’s needs, including when they reach adulthood.
A 529 college savings plan is designed explicitly for education-related costs, often providing more tax benefits but less flexibility in how the funds are used.
Best Practices for Custodial Accounts
- Choose investments that match the long-term goals of the account, such as saving for college or future living expenses.
- Diversify holdings by including various investment types like stocks, bonds and mutual funds, which can help balance risk and increase potential growth over time.
- Regularly review account statements to stay on top of changes or fluctuations in the account’s value.
- Budgeting or financial tracking tools can also help monitor progress towards financial goals and help you to make necessary adjustments.
- Decisions about the account should prioritize the minor’s best interests rather than personal gain. Maintain records of transactions to ensure honest, ethical management of the funds.
Is a Custodial Account Right for Your Family?
Custodial accounts are a great way to save for future needs like saving for long-term goals like education or establishing financial security for a child.
Before opening a custodial account, consider the minor’s specific needs, the account’s tax implications, and your ability, as the account custodian, to commit to ethical and transparent management of funds.
Check out our list of best savings accounts for kids and custodial Roth IRAs.
FAQ
Here are the answers to some of the most frequently asked questions regarding custodial accounts.- Are custodial accounts a good idea?
- Yes, custodial accounts are a great way to teach a minor about money and have them be in charge, with your help, of their finances. Here are some things to know:
- Custodial checking accounts allow you to make frequent withdrawals.
- Custodial savings accounts are more focused on storing money that your child can access when he or she is older.
- It's a good option if your child is a teenager and has a job where they can contribute their own money.
- Yes, custodial accounts are a great way to teach a minor about money and have them be in charge, with your help, of their finances. Here are some things to know:
- What is better: a 529 account or a custodial account?
- Though both have merit, a 529 plan is a college savings plan sponsored by a state or state agency, so will not necessarily be as easy to open as a regular custodial account.
- Can a parent take money from a custodial account?
- No, any money, even if you're the one who has contributed it, is your child's. Once the money has been deposited, it will belong to the account holder, which is your child.
- What are the cons of a custodial account?
- Some cons of custodial accounts that you should consider are:
- The funds will only pass to the child upon the age of majority
- Fewer tax advantages than other accounts
- Some cons of custodial accounts that you should consider are:
Sam DiSalvo contributed to the reporting for this article.
