Custodial Accounts Explained: A Parent’s Guide to Saving for Kids

Every parent wants to give their child a strong start in life, and one of the most impactful ways to do that is by setting aside money for their future.

From college tuition and first apartments to unexpected opportunities or challenges, having a financial cushion can make a world of difference as your child transitions into adulthood. But with so many savings options available, figuring out the right path can feel overwhelming.

That’s where custodial accounts come in. These accounts allow parents, grandparents, or other adults to put money away for a child’s benefit while still maintaining control until the child is old enough to manage it themselves.

Unlike college-specific savings tools such as 529 plans, custodial accounts are incredibly flexible. They can be used for just about any expense that helps your child build their future.

This guide will break down everything you need to know about custodial accounts: what they are, how they work, their advantages and drawbacks, and how they compare to other savings options.

Whether you’re just starting to think about financial planning for your child or you’re exploring new ways to diversify your family’s savings strategy, this complete guide will help you make informed decisions with confidence.

What Is a Custodial Account?

At its core, a custodial account is a financial account that an adult manages on behalf of a minor. These accounts are governed by state laws such as the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), both of which provide a framework for transferring assets to children without the need to set up a formal trust.

When you open a custodial account, you (the custodian) maintain control over the money or investments in the account until your child reaches the “age of majority,” which is typically 18 or 21, depending on your state. While you control how the funds are managed and spent during this time, the assets technically belong to the child and must be used for their benefit.

Custodial accounts can be tailored to fit your family’s goals, whether you want to focus on conservative savings or take a longer-term investment approach.

Key Benefits Of Custodial Accounts

Custodial accounts offer families a unique mix of flexibility and accessibility, making them a popular choice for parents and grandparents who want to invest in a child’s future.

Unlike highly specialized accounts, they strike a balance between growth potential and practical use. Here are some of the main benefits:

Flexibility In Use

One of the biggest advantages of a custodial account is that the funds aren’t restricted to education expenses.

While a 529 plan limits you to qualified education costs, a custodial account can be used for just about anything that benefits the child, whether that’s paying for college, buying a first car, helping with extracurricular activities, or even providing seed money for a future business venture.

Wide Range Of Investment Options

Custodial accounts can hold more than just cash. Depending on whether you choose a UGMA or UTMA account, you can invest in stocks, bonds, mutual funds, ETFs, or other assets.

This means you’re not limited to low-growth savings accounts. You can give your child’s money the chance to grow significantly over time.

Teaching Tool For Financial Literacy

Custodial accounts provide a natural opportunity to involve kids in learning about money.

As your child grows, you can show them how deposits, investments, and interest work. By the time they take full ownership of the account at adulthood, they’ll already have experience in understanding financial responsibility.

Drawbacks Parents Should Consider

While custodial accounts offer plenty of advantages, they aren’t perfect for every situation. Before opening one, it’s important to understand the potential downsides so you can plan accordingly.

Loss Of Control When Your Child Reaches Adulthood

Perhaps the biggest drawback is that once your child reaches the “age of majority” (usually 18 or 21, depending on your state), the account legally becomes theirs.

At that point, they gain full control over how the money is used, even if you had intended it to go toward education or another specific goal. For some families, this loss of control can feel risky, especially if they’re unsure how financially responsible their child will be at that age.

Impact On Financial Aid

Custodial accounts are considered the child’s asset, not the parent’s. This matters when it comes to financial aid applications like the FAFSA.

Because assets in the child’s name are weighed more heavily than those in the parent’s name, having a large custodial account could reduce your child’s eligibility for need-based aid.

Tax Considerations (Kiddie Tax)

The IRS has special rules for unearned income in custodial accounts, often referred to as the “kiddie tax.”

While the first portion of investment income may be tax-free and the next portion taxed at the child’s rate, any amount above that is taxed at the parent’s higher rate. This can limit some of the potential tax advantages families might expect.

Irrevocable Contributions

Once money or assets are placed in a custodial account, they legally belong to the child. You can’t take them back, even if your financial situation changes. This lack of flexibility can be a downside for parents who prefer to maintain more control over their savings.

While custodial accounts can be a powerful tool, they aren’t without strings attached. Weighing these drawbacks against the benefits can help you decide whether they’re the right fit for your family’s financial goals.

Custodial Accounts vs. Other Saving Options

Custodial accounts can be a valuable tool, but they aren’t the only option parents have when it comes to saving for their child’s future. To decide if they’re the right fit, it helps to compare them with some of the other common savings vehicles available to families.

Custodial Accounts vs. 529 Plans

• 529 plans are designed specifically for education, with strong tax advantages if funds are used for qualified expenses like tuition, books, or room and board. They’re ideal if college is the primary savings goal.

• Custodial accounts are more flexible, since funds can be used for any purpose that benefits the child, not just education. However, they don’t offer the same level of tax perks as 529 plans.

Custodial Accounts vs. General Savings Accounts

• General savings accounts are easy to open and highly liquid, but they typically earn very little interest and don’t provide the same long-term growth potential.

• Custodial accounts can hold investments like stocks or mutual funds, giving your child’s money more opportunity to grow. That said, they require more oversight than a simple savings account.

Custodial Accounts vs. Trust Funds

• Trust funds give parents far more control over how and when assets are used, but they’re more expensive and complex to set up, often requiring legal help.

• Custodial accounts are simpler and more affordable, making them accessible to most families, though you lose control once your child reaches adulthood.

Custodial accounts are best suited for families who want a balance of flexibility and growth potential, but don’t need the heavy tax benefits of a 529 or the rigid control of a trust. Many parents actually use a mix of these tools, like pairing a custodial account with a 529 plan, to create a more complete savings strategy.

Custodial accounts can be a powerful way to set your child up for success, offering flexibility to pay for a wide range of needs while also giving your contributions room to grow through investments. They’re simple to open, easy to manage, and provide a meaningful way for family members to make financial gifts that will last far beyond birthdays or holidays. 

Like any other financial tool, custodial accounts come with trade-offs, which is why it’s so important to weigh both the benefits and drawbacks before deciding if a custodial account fits into your family’s bigger financial picture. 

For many families, custodial accounts are part of a blended strategy. You might use a custodial account in tandem with 529 plans or general savings accounts to create balance in your financial plan.

At the end of the day, what matters most is that you start saving consistently. Small contributions made now have time to grow into significant financial support for your child’s future, whether that future includes college or launching a career.

By exploring all your options, you’re setting your child up for freedom, opportunity, and a stronger foundation for adulthood.