Custodial account

Custodial Account

An account at a bank, brokerage, or insurance company held by an adult guardian on behalf of a minor child. That is, the minor child owns the custodial account, but the parent or guardian manages it and makes all decisions related to it. The child takes control of the account at a certain age: 18, 21, or 25, depending on the jurisdiction. Importantly, the account is taxed at the guardian's marginal tax rate until the child turns 18, at which point it is taxed at the child's rate.

Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

Custodial account.

If you want to make investments on a minor's behalf, or transfer property you own to that person, you can open a custodial account with a bank, brokerage firm, mutual fund company, or insurance company.

You name an adult custodian for the account -- either yourself or someone else -- who is responsible for managing the account until the child reaches the age of majority.

That age may be 18, 21, or 25 depending on the state and the type of account you choose. At majority, the child has the legal right to control the account and use the assets as he or she chooses.

There may be some tax advantages in transferring assets to a minor. If the child is under 18, investment earnings above a specific level that Congress sets each year are taxed at the parents' marginal tax rate.

But if the child is 18 or older, all investment earnings are taxed at the child's rate -- again, typically the lowest rate. In addition, gifts you make to the account are no longer part of your estate, which may reduce vulnerability to estate taxes. However, it's wise to review your plans with your legal and tax advisers.

One drawback of a custodial account is that the assets are considered the property of the child, and may reduce the amount of financial aid the child qualifies for when he or she enrolls in a college or university.

Dictionary of Financial Terms. Copyright © 2008 Lightbulb Press, Inc. All Rights Reserved.