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Everything You Need to Know About Custodial Account Taxes

Custodial accounts have certain tax advantages that other options don’t. This EarlyBird guide explains how custodial account taxes work.

Last updated:

April 11, 2022

EarlyBird helps parents, family, and friends collectively invest in a child’s financial future. Learn more.

What You'll Learn

Creating a custodial account for a child is a great way for you and the rest of the family to prepare them for financial success early.

But as with any other investment, there are key regulations you need to be aware of when setting up an account. When it comes to taxes in particular, not even an account created for a minor is entirely exempt.

That said, custodial accounts do have certain tax advantages that other options don’t.

So whether you’ve already set up a custodial account or you’re about to, here’s everything you need to know about how they work regarding taxes.

What is a Custodial Account?

Before we dive right into custodial account taxes and how they work, it’s worth taking a step back to explore how custodial accounts work.

A custodial account is a dynamic investment vehicle that adults can use to save assets for children until they come of age.

When you set up a custodial account, you’ve got to choose a minor beneficiary. 

As the adult who owns the account, you’ve got to serve as the custodian of the assets that are being kept in the account. 

But even though you’re in charge of managing the custodial account, it’s important to note that everything in the account is the legal property of your minor beneficiary.

When the child you’re saving for hits the “age of majority” in their state, the custodianship ends, and the assets pass on to the full control of the named beneficiary. In most states, the age of majority is either 18 or 21.

Why do adults use custodial accounts to save for kids?

There are quite a few benefits to break down here. But above all else, investing early in a child’s financial future gives you time to build up a big nest egg and generate compound interest that will give the kids you love some incredible financial opportunities when they come of age.

Line graph showing how time length impacts savings.
(Image Source)

There are two main types of custodial accounts: Uniform Gifts to Minors Act (UGMA) accounts and Uniform Transfer to Minors Act (UTMA) accounts. 

Both account types are named after the legislation that created them and offer the same tax benefits. But we’ll get down to those tax benefits shortly.

While both the UGMA and UTMA are fantastic options for adults wanting to invest in a child’s financial future, there are some key differences you’ve got to be aware of.

UGMA account

When it comes to custodial accounts, UGMA accounts are generally the most popular choice.

The Uniform Gifts to Minors Act (UGMA) was passed in 1956, and it was then revised in 1966. 

UGMA accounts are designed to help adults save and accumulate financial assets for a child. UGMAs are ideal for saving cash, individual stock shares, bonds, exchange-traded funds (ETFs), index funds, and mutual fund shares. Some UGMA accounts can also hold insurance policies.

The key advantage that UGMAs have over UTMA accounts is that adults can open a UGMA account in all 50 US states. By contrast, UTMA accounts aren’t available everywhere in the US because not every state ratified the Uniform Transfer to Minors Act when it was created in the 1980s.

Another thing to bear in mind is that the custodianship of assets on a UGMA account doesn’t normally last as long as a UTMA account. 

The age of majority for a UGMA account in most states is either 18 or 21. But if you go for a UTMA account, your named beneficiary might not be able to access the funds you’re saving for them until age 25.

If UGMA custodial accounts sound like a good fit for you and the kids in your life, it’s worth checking out EarlyBird. Using our simple and intuitive app, any adult can help to fund a child’s financial future in an organized and tax-beneficial way.


UTMA account

Next, you’ve got UTMA custodial accounts. UTMA custodial accounts are really similar to UGMA accounts, but there are a couple of differences you’ve got to be aware of.

First and foremost, UTMA accounts are designed to hold a broader range of assets than a UGMA account. 

In addition to the financial assets that a UGMA can hold, you can also use UTMAs to hold things like fine art, real estate deeds, and intellectual property like patents to inventions.

You’ve also got to remember that UTMA accounts aren’t available in all 50 states.

Plus, each state has different rules on the age of majority — but in some US states, the adult can retain custodianship until the child reaches age 25.

Because most of us haven’t got many Picassos sitting around, families generally just pick the UGMA instead. 

But, if you do have less tangible assets or you want to withhold those assets from your named beneficiary until they’re a bit more mature, a UTMA could be the right choice. 

Want to learn more about UTMA account rules? We spell everything out in this guide.

Custodial Roth IRA

While UGMA and UTMA custodial accounts are definitely the more popular options when it comes to custodial accounts, it’s worth quickly talking about custodial Roth individual retirement accounts (IRAs).

Using a custodial Roth IRA, an adult can set up an account and deposit a child’s earned income.

Translation: the Roth IRA is really only designed to save for kids who are generating income. 

For example, if a child is making money babysitting, mowing lawns, or working part-time at a grocery store, you can deposit their income into a custodial Roth IRA before they come of age.

Just like a normal custodial account, you as the adult will be responsible for managing the funds and investment decisions associated with the account. 

But once the child hits the age of majority, they take control of the assets — which have then got to be transferred to a regular Roth IRA account in their own name.

The major benefit of a custodial Roth IRA is that it enables you to grow the child’s assets tax-free. 

But a child beneficiary can only enjoy that tax benefit if they hold onto those assets until they reach the age of retirement. If they make any withdrawals before hitting that age — or you make withdrawals on their behalf as a custodian — you’ll have to pay an IRS penalty.

Chart showing example amount of money generated through Roth IRa based on time saved.
(Image source)

How are Custodial Accounts Taxed?

No matter which type of custodial account you go for, you’re going to enjoy one key tax benefit.

Because all of the assets that are held in a custodial account are the legal property of the child beneficiary, that means a big chunk of the unearned income each custodial account generates is taxed at the child’s lower rate.

That lower rate applies up to a certain threshold, and then everything above the threshold is then taxed at the adult custodian’s higher rate. 

For most families, this creates a pretty large tax savings. But there are a few key points to consider here, so we’ll quickly break down all the rules on custodial account taxes.

Capital gains taxes on custodial accounts

The key custodial account tax rule you’ve got to understand is the IRS “kiddie tax”. The kiddie tax is used to tax a child’s capital gains and unearned income accumulated over the course of a tax year.

Under the kiddie tax, the first $1,100 worth of a child’s capital gains generated during a given tax year won’t be taxed at all. The next $1,100 in unearned income is then charged at the child’s tax rate. Everything above $2,200 will be taxed at the adult custodian’s tax rate.

Before you start adding up the numbers, you’ll be glad to hear that the kiddie tax rules don’t apply to a child’s salary or wages they receive from employment — it’s only unearned income

So if your 15-year-old earned $1,500 painting apartments over the summer, and their custodial account generated $1,050 in capital gains, that account would still be sitting below the 0% threshold for unearned income.

The kiddie tax applies to children under 19 years old, as well as full-time students under 24 years old who are filing under their parents’ tax return.

Account gains are only taxed when they’re sold — and because you’re investing long-term in a child’s future, you aren’t going to be selling many assets on an annual basis. So most of your taxable gains will be from compound interest or dividend payments.

Custodial accounts aren’t tax-deferred. 

As a result, you can make penalty-free withdrawals from a UGMA or UTMA account — but only if you can demonstrate that the money you’re taking out is going to go towards helping the named beneficiary. One of the most typical withdrawal reasons is to pay for education.

After the child reaches the age of majority, they can withdraw the funds for any reason.

While the IRS doesn’t penalize you for withdrawals, you’ll need to pay tax on any capital gains associated with a withdrawal. That will generally be taxed at the child’s lower rate.

Contributions to a custodial account aren’t tax deductible. 

That being said, you can contribute quite a bit of money to a custodial account by utilizing the IRS gift tax rules.

Chart showing how your annual exclusion limit feeds into your lifetime exclusion.
(Image source)

Under the IRS gift tax, you can give up to $15,000 per child per year in gifts to a child without having to pay tax or declare that gift. If you joint file as a married couple, that annual exclusion jumps up to $30,000 per child per year.

That means you’re allowed to contribute up to $15,000 each year to a child’s custodial account without having to pay tax on that gift. Anything above that amount needs to be declared to the IRS, and you may need to pay a tax on it.

Who pays taxes on a custodial account

Everything in a custodial account is the legal property of its child beneficiary. But as the adult custodian, you’re responsible for managing those assets. That means it’ll fall upon the custodian to file any necessary tax forms and ensure taxes on capital gains and unearned income are paid.

Again, it’s important to note that anything up to $2,200 per year in unearned income is taxed at the child’s lower rate — while anything above that amount is taxed at the custodian’s rate. 

That rate will depend on whether you file your taxes on a single or joint basis, your annual taxable income, and whether you’re the head of your household.

How to report custodial account taxes

As the adult custodian or a UGMA or UTMA account, you’re responsible for reporting any taxable gains or taxable income.

If a child’s custodial account has generated unearned income, you’ve got to report it to the IRS using Form 8615. This form needs to be submitted annually alongside the child’s Form 1040.

Screenshot of Form 8615
(Image source)

You might not need to file a separate tax return for a child. If their income only consisted of interest, dividends, and capital gains from mutual funds, you can include their income on your own 1040 and pay whatever is owed on your return instead.

If you want to go for that option, you’d need to fill out Form 8814 and include it alongside your return. 

This route is a whole lot more convenient and saves you time filing. But beware that if you use Form 8814, the tax paid on the child’s custodial account will be at your higher rate — not the child’s rate.

If you’ve gifted above the annual gift exclusion amount of $15,000 per child per year, you’ll also need to include a gift tax Form 709 alongside your own tax return.

What Happens to Custodial Account Assets After Death?

When you set up a custodial account for a child, you’ll often be given the chance to appoint a successor custodian who can assume control of the account if something happens to you. 

The account value is part of the minor’s estate. In the event of a custodian’s death, they can appoint a successor in their will. If a successor hasn’t been designated and the child beneficiary is over age 14, the beneficiary can pick their own custodian via notarized letter.


When it comes to the IRS and taxes, you can’t afford to mess around. To avoid penalties, you’ve got to do your homework and make sure you fully understand your filing obligations as the manager of a custodial account.

Fortunately, custodial account taxes are relatively straightforward. Just remember that as the custodian, it’s your job to manage the child’s assets, file, and make sure any taxes owed get paid.

Ready to experience custodial accounts first-hand? Download the EarlyBird app now and start investing in a child’s future.


This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.


EarlyBird Team

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