What is a Custodial Account?

According to the above definition, it is quite clear that two parties are involved: the custodian and the beneficiary. One can open a saving account with a financial institutionFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more or bank, which allows the responsible party to invest the number of other parties for a specific period in this type of account.

Further, one can open a custodial account using various forms, including one for minors where the custodian is usually the minor’s parent. Another form is operated and owned by companies, individuals, or institutions to distribute funds in such accounts rapidly.

How Does a Custodial Account Work?

A custodial account is like a regular savings account. A custodian makes decisions about when and how much money to invest in a custodial account. Here, the account manager is a person who makes a continuous contribution to the find.

Further, one can use it to invest funds in various assets, but it depends on the financial institutions accepting the investment in a particular asset. In the case of a custodial account for a minor, one can invest the amount in the account by the minor’s legal guardian or parent. The amount is kept in a custodial account till the minor reaches the age of majority.

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Types

The following are the major types one could open with a financial institution on the current date.

#1 – Uniform Transfers to Minor Act Account (UTMA):

This account can hold almost all  types of assetsThe Types Of AssetsAssets are the resources owned by individuals, companies, or governments expected to generate future cash flows over a long period. There are broadly three types of asset distribution: 1. Based on convertibility (current and non-current assets), 2. Physical existence (tangible and intangible assets), 3. Usage (operating and non-operating assets)read more in the pool of investments, including real estate, Intellectual Property (IP), etc. It is, hence, the most significant benefit of this investment. Almost all the financial institutions in the U.S. allow this type of account.

#2 – Uniform Gift to Minor Act Account (UGMA):

This type is used as a gift to the minor once they attain the age of majority. It is pertinent to note that the UGMA account is limited to stocks, cash, bonds, shares, etc., against all the assets under the UTMA account.

How Do You Open a Custodial Account?

  • Firstly, one can easily open a custodial bank account since it has straightforward procedures.A person can open an account online on the broker’s website or other financial institutions. Else, a person can go individually to the broker’s branch and request to open a bank account. Before opening a custodial bank account with any broker, the fees, payment and contribution structure, and interest rate are essential.

Example

A custodial account is an excellent way of providing a facility to children of the age, not the majority. For example, one can prepare a Trust fundTrust FundA trust fund is a legal entity formed as part of an estate planning tool which holds a grantor’s assets and duly distributes them to the inheritors after the grantor passes away.read more for children of minority age, which provides the funds at the age of majority as a gift to them. Thus, suppose $10 million is being invested in a trust fund for two children in a family by their parents; consider the age of maturity ten years from opening a custodial account for both children.

After adding up interest over ten years to $10 million, suppose the amount comes to $35 million. The $35 million Shelby now divided between the children pre-specified the specified ratio of 4:3. Thus, child A will get the funds of $20 million, and child B will get $15 million from the trust fund.

Custodial Account vs. Deposit Account

In a custodial account, the banks hold investments on behalf of the responsible person for another person’s benefit. Generally, the minors, since the person does not have the legal rights on the investments.

However, a deposit account is an account where the banks and the financial institutions are responsible for the accounts, for example, the saving bank accounts.

Benefits

The following are the essential benefits: –

  • The most significant advantage of this kind of account is that it keeps the money of dependent people safe and secured until the right time. For example, the achievement of the majority age.The custodial account comes with a significant level of flexibility since there are no specific income or contribution limits.It has the option of investing contributions to various kinds of assets. However, exceptions are always there.Establishing a trust fund is more beneficial and cheaper than setting up a trust fund in a bank or other financial institution.Further, there are also various tax benefitsTax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more to individuals.

Limitations

  • Once one deposits the money in a custodial account, the capital’s ownership is transferred instantly to the beneficiary or the child. Thus, a person can do no action to restore the money.It counts the fund in the asset fund of the child even though the money is receivable on a future date when the child is a beneficiary.Even though tax advantageTax AdvantageTax Advantage are the types of investments or saving plans that benefit tax exemption, deferred tax, and other tax benefits. Examples include Government bonds, Annuities, Retirement Plans. read more is received, it is comparatively lesser than other accounts.

Conclusion

Thus, a custodial account becomes very important for opening a special fund for children or minors by providing their funds at the right time when they attain the majority. Thereby keeping them apart from their funds from the beginning.

This article is a guide to Custodial Account and its definition. Here, we discuss types, examples and how do custodial accounts work along with benefits. You can learn more about financing from the following articles: –

  • Investment Trust DefinitionTrust AccountNostro AccountLetter of Guarantee