Whys and Wherefores of Custodial Accounts
1 Timothy 5: 8 says If anyone does not provide for his relatives, and especially for members of his household, he has denied the faith and is worse than an unbeliever. Christian parents take that verse quite seriously, wanting to give their kids everything they need, and even a life better than they had. Today we’ll talk about a tool that can help you do that. Here’s one more key verse for our conversation today: Proverbs 13: 22 reads, A good man leaves an inheritance to his children's children We’ve been getting a lot of calls lately about one of the ways that parents and grandparents can do that with a custodial account. It’s a great way to start building that inheritance for kids. CUSTODIAL ACCOUNTS What exactly is a custodial account? Much as the name suggests, it’s a savings or investment account set up in a minor child's name where you are the custodian. Technically, the child is the owner of the account, but you remain in control to act in the child’s best interest. Whether for saving or investing, a custodial account comes with few strings attached for how the contributions and earnings can be used for the child’s welfare. That’s quite different from other types of accounts set up in a child’s name, such as a 529 education savings account where withdrawals must be used for eligible expenses or you incur taxes and penalties. Federal law provides for two types of custodial accounts, but since the version set up under the Uniform Gift to Minors Act or UGMA allows for most kinds of investments. We’ll concentrate on that one. And it’s good to know that UGMA accounts are allowed in all 50 states. And while conventional custodial accounts are inexpensive and a breeze to set up they’re not perfect. So let’s get into the pros and cons. First, the pros: THE PROS OF CONVENTIONAL CUSTODIAL ACCOUNTS We mentioned that custodial accounts are easy and inexpensive to set up. This is especially true when compared to a trust that could cost around $1500 to establish and comes with certain legal requirements. Next, a custodial account provides a tax benefit to the person setting it up. Once assets go into the account, they become part of the child’s estate, they can never go back into your estate, and are no longer counted against you for tax purposes. You can fund a custodial account with up to $16, 000 in 2022 without having to fill out the IRS gift tax form 709. Contributions above that limit will count against your lifetime exemption of $12. 06 million, so that shouldn’t be a problem. There’s also a tax benefit for the minor, sort of, because his or her income is taxed at a lower rate. But it’s important to know the rules for the so-called kiddie tax, enacted to prevent parents from transferring large sums to their minor children to escape higher tax rates. Under the kiddie tax: - The first $1, 150 of investment income, meaning money earned by the investment is covered by the kiddie tax's standard deduction, so it isn't taxed. - The next $1, 150 is taxed at the child's marginal tax rate. - Anything above $2, 300 is taxed at the parents' marginal tax rate. And one final advantage to a custodial account is you can invest the funds in anything offered by the financial institution administering the account, although many institutions prohibit putting assets into high risk investments like futures or derivatives. THE CONS OF CONVENTIONAL CUSTODIAL ACCOUNTS Now here are the cons: First, you can’t change your mind. Once your funds go into the child’s custodial account, the child legally owns them, and only the child can withdraw funds from the account upon reaching the age of majority, which is 18 in most states, and at that age, the child can use the funds however they want. You have no control over the money. There are certain limited circumstances where you can withdraw funds, but you need to show they were used for the child’s benefit and not yours or you’ll open yourself up to legal problems. Buying a car or taking a family vacation with the money won’t qualify. And since the child legally owns the assets in the account, they’ll be counted against that child when it comes to federal financial aid for education. If there are substantial assets in the account, the child may not be eligible for grants and some student loans. Also, you can’t take a deduction for funds going into a custodial account, and when the child comes of age and withdraws funds, the child will have to pay capital gains taxes on the earnings. Well, those are the whys and wherefores of custodial accounts. I hope you find the information helpful. On today’s program, Rob also answers listener questions: ● Should you take money out of a Roth IRA to invest in I-bonds? ● How do you determine if you’re eligible for student loan forgiveness? ● How should you advise an adult child about renting a room to someone who is not a Christian and may be involved in a cult? ● Should you invest heavily in precious metals to guard against a collapse of the banking system? RESOURCES MENTIONED: ● Xx