What is a Custodial Account?
Custodial Account is a savings account at a financial institution like banks, mutual funds, insurance companies, non-banking financial institutions, stockbrokers, etc, that is maintained mainly for the benefit of beneficiaries while it is continuously administered by a person termed as responsible person or custodian or the legally recognized guardian .
According to the above definition, it is quite clear that there are 2 parties involved – the custodian and the beneficiary party. A saving account is opened with the financial institutionsFinancial 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. or banks, which provides a facility to the responsible party to invest the set aside the number of other parties for a specific period in this type of account.
Further, a custodial account can be opened using a variety of forms, including one for minors where the custodian is usually the minor’s parent. Another type of form is used and owned by companies, individuals, or institutions for the rapid distribution of funds in such accounts.
How Does a Custodial Account Work?
A custodial account is like a regular saving account. Here, a custodian is someone who makes decisions about when and how much money to be invested in a custodial account. Here, the account manager is a person who makes a continuous contribution to the find.
Further, it can be used to invest funds in a variety of assets, but it depends upon the financial institutions whether to accept the investment in a particular asset. In the case of custodial account for a minor, the amount is invested in the account by minor’s legal guardian or parent. The amount is kept in a custodial account till the minor reaches the age of majority.
The following are the major types that could be opened with a financial institution on the current date.
#1 – Uniform Transfers to Minor Act Account (UTMA):
This account can hold almost all the types of assets in the pool of investments, which include real estate, intellectual property (IP), etc. It is hence the most significant benefit of this kind of investment. Almost all the financial institutions in the US allow this type of account.
#2 – Uniform Gift to Minor Act Account (UGMA):
This type is used for a gift to the minor once they attain the age of majority. It is pertinent to note here that the UGMA account is limited to stocks, cash, bonds, shares, etc. as against all the assets under the UTMA account.
How Do You Open a Custodial Account?
- Firstly, a custodial bank account can be opened very comfortable since it has straightforward procedures for opening an account.
- A person can either open an account online on the website of the broker or other financial institutions, or a person can go individually to the branch of the broker and request to open a bank account. Before deciding to open a custodial bank account with any broker, essential aspects to be taken into considerations are the fees, payment and contribution structure, and the rate of interest.
A custodial account is an excellent way of providing a facility to children of the age, not what of the majority. 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. can be prepared for children of minority age, which provides the funds at the age of majority as a gift to them. Thus, suppose 10 million dollars is being invested in a trust fund for 2 children in a family by their parent. Now consider for both the children what is the age of maturity 10 years from the date of opening a custodial account.
After adding up interest over 10 years to 10 million dollars, suppose the amount comes to 35 million dollars. This amount of 35 million dollar Shelby now divided between both the children in pre specifies the specified ratio of 4:3. Thus child A will get the funds of $20 million, and child B will get the fund of $15 million from the trust fund.
Custodial Account vs. Deposit Account
A custodial account is an account where the banks are holding investment on behalf of the responsible person for the benefit of another person, generally the minors, since the person doesn’t 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.
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 limits of income or contribution.
- It has the option of investing the contributions to various kinds of assets. However, exceptions are always there.
- For establishing a trust fund, it is more beneficial and cheaper to establish a trust fund in a bank or any 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. to individuals.
- Once the money is deposited in a custodial account, the ownership of money is instantly transferred to the beneficiary or the child; thus, no actions to restore the money can be done.
- Where the child is a beneficiary, such money is counted in the asset fund of the child, even though the money is receivable on a future date.
- 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. is received, but it is comparatively lesser than other accounts.
Thus custodial account becomes very important for opening a special fund of children or the minor by providing with their fund at the right time when they attain the majority and thereby keeping apart from their funds from the very beginning.
This article has been a guide to what is a custodial account and its definition. Here we discuss types, examples, and how to open a custodial account along with its working and benefits. You can learn more about financing from the following articles –