How to Open a Custodial Account: The Complete Guide

November 11, 2021
financial literacy

If you want to invest in a child’s financial future and create a nest egg that you can pass on to the kids you love, you’re probably going to want to consider investing in the stock market.

The value of investments like stock shares, mutual fund shares, and exchange-traded fund (ETF) shares do go up and down over time based on market conditions. 

But, investing in the market is a fantastic way to build generational wealth that you’ll be able to share with your loved ones when they need it — if you do it wisely. 

Unfortunately, you can’t just give kids a load of stock shares and let them start trading. Under-18s can’t buy or sell stock. But if you want to invest in assets like that for children, the best way to do it is by setting up a custodial brokerage account.

This guide explains what a custodial brokerage account is, the different types of custodial brokerage accounts, and how to choose the right account provider for you.

What is a Custodial Account?

A custodial account is a type of investment account that an adult can set up for a child as a way to give them a head start on their financial future.

Note: ​​A "custodial account" can also refer to a custodial bank account that's used to hold savings for a child. However, when we use the term in this guide, we're referring to custodial brokerage accounts used for investments. For a beginner's guide to the topic, check out "What is a custodial account?"

Most adults who choose to open a custodial account do so because minors can’t open brokerage accounts themselves. 

Most brokerage firms require you to be at least 18 years old before you start trading stocks — so these accounts allow loved ones to give financial gifts that can grow and compound throughout a young person’s life.

More often than not, you’ll probably hear people refer to a custodial brokerage account as just a “custodial account.” 

For all intents and purposes, they mean the same thing — and no matter which type of custodial brokerage account you’re setting up, they all function the same way.


Illustration of hand placing coin in row of gifts


When you open up a custodial account for a child, you need to appoint a minor beneficiary. This is someone under the “age of majority,” and all of the assets you place into the brokerage account are the legal property of that child.

But because a child can’t buy or sell a lot of the asset classes you’d get in a brokerage account (like stock shares or mutual fund shares), the adult has to serve as the account custodian. 

The account custodian is responsible for making all the investment decisions relating to the assets stored in that account — even though nothing in the account belongs to them.

When the child beneficiary reaches the age of majority in their state, the custodianship ends, and the (now adult) beneficiary takes control of the assets.

If you gift stock or other investments to a custodial brokerage account, it’s important to note that everything you put into a custodial account is irrevocable. Translation: once you’ve contributed to a custodial account, you can’t take it back — the investment officially belongs to the beneficiary (child). 

In terms of the assets a custodial account can hold, you’re looking at a pretty flexible range of options. 

Different custodial account types can hold different assets. But no matter which account type you choose, you’ll be able to invest in assets like stocks, bonds, money, exchange-traded funds (ETFs), mutual funds, and more.

Why Open a Custodial Account?

Buying or selling stock shares is not really possible if you’re under 18. That’s because to trade shares on the stock market, you’ve got to have a brokerage account with a stockbroker.

Since most brokerages require you to be at least 18 to set up your own account, the bad news is that children can’t invest directly in company stocks, bonds, mutual funds, or ETFs.

The good news is that children can still own stock, mutual fund shares, or a load of other asset classes. You’ve just got to purchase it for them.

That’s where a custodial brokerage account comes in handy.

By setting up a custodial account, you can gift investments that legally belong to a child — enabling them to learn how to invest. 

Fortunately, as the custodian, you are responsible for managing those investments until the child has developed all the financial skills they need to start trading on the market for themselves.

But the benefits of custodial accounts stretch beyond just the ability to trade on the market.

Illustration of woman drawing a line graph

First and foremost, custodial accounts give you a tax advantage over stashing money in a normal savings account or checking account. 

Because the child legally owns the assets in the investment account, the first $2,200 of unearned income from the account is normally taxed at the child’s lower tax rate (if at all).

That can potentially save families a pretty hefty sum in tax receipts when January rolls around.

You also get a whole lot of flexibility with a custodial account. 

When you set up a custodial brokerage account for a child, you’re normally able to withdraw funds before the child comes of age, as long as those withdrawals are for the direct benefit of the child beneficiary. 

That means if the child in your life needs a hand paying for something like tuition at a private high school, you can take money out of the child’s brokerage account without getting penalized.

Custodial accounts also offer a lot of flexibility from the point of view of the real account owner (the child).

After your beneficiary reaches the age of majority, control of all the assets you’ve saved for them automatically passes on to them. They’re then free to do whatever they want with those assets — and can make withdrawals to do whatever they want.

You aren’t going to get that sort of flexibility with most other investment accounts. 

For example, a 529 college savings plan or a Coverdell ESA would limit your beneficiary to just educational expenses. That means if a 529 beneficiary wanted to buy a new car to drive to college, they couldn’t touch their 529 investments.

That could end up putting them in a pickle, which is why custodial brokerage accounts are a dynamic option for both kids and adults investing on their behalf.

More important still, custodial accounts don't have a contribution limit. That means your custodial account contribution can be as much as you want (just think about how the gift tax limit may impact it).

What Are the Different Types of Custodial Accounts?

At this point, we’ve already walked you through how custodial brokerage accounts work and why they’re such a great way to invest for the kids in your life. Now, let’s talk about the different types of custodial accounts.

Generally speaking, there are two main account types on offer when we talk about custodial accounts: a UGMA custodial account and a UTMA custodial account. 

Although they both work pretty similarly in principle, there are a couple of key differences between UGMA and UTMA that you should bear in mind.

UGMA custodial account

The UGMA is named after the Uniform Gifts to Minors Act (UGMA), which is the law that created it.

UGMA accounts were first developed in 1956 as a way to help individuals give assets to underage beneficiaries. The act was tweaked and updated in 1966, and it’s since been adopted by all 50 U.S. states.

UGMA custodial accounts are designed to hold common financial assets like money, company stock shares, bonds, mutual funds, ETF shares, and more.

The age of majority for UGMA accounts is typically either 18 or 21, but this varies from state to state.

Because UGMA accounts allow adults to invest in a broad range of assets for the kids they love — and you can set up a UGMA in all 50 states — they tend to be the more popular option when it comes to custodial brokerage accounts.

But we’ll quickly walk you through UTMA accounts, too.

UTMA custodial account

The other kind of custodial brokerage account you’ll often hear about is a UTMA account. 

Like UGMA accounts, the UTMA account is named after the legislation that created it: Uniform Transfers to Minors Act (UTMA)

The UTMA was created about 30 years after the UGMA account was created, and it’s designed to hold a slightly wider range of assets. 

While UTMA accounts can hold the same sort of financial assets UGMAs can hold, adults can also gift less common assets to a child’s custodial account. 

By “less common,” we’re talking about intellectual property, fine art, or fractional shares in a family limited partnership.

Key differences between UGMA and UTMA

In terms of how they function, UGMA and UTMA custodial accounts are pretty similar. 

Both custodial account types are designed to help an adult invest in the financial future of a child. 

They both enable you to gift assets into an account on behalf of a child beneficiary — and you, as the adult, are responsible for managing those assets until the child comes of age. Once a child beneficiary reaches the age of majority, the assets will pass on to them.

But there are a few key differences you’ve got to consider.

First and foremost, the UTMA can hold a wider range of assets. That means if you’ve got a collection of fine art or hold a bunch of trademarks you want to pass onto future generations, a UTMA is a smart way to do it. 

Then again, average families don’t tend to have a lot of these less common assets lying around — which is part of the reason UGMAs tend to be more popular.

It’s also important to note that the age of majority for UTMAs is higher in some states. 

Table showing age of majority for UGMAs and UTMAs in each state
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If the child you’re investing for doesn’t have many financial literacy skills, that might be a good thing. But if the kid in your life has got a good head on their shoulders, a longer wait means they won’t be able to access the investments you’ve been making for them.

That could put a big damper on their future plans.

Finally, UTMAs aren’t available in every U.S. state. Because not every state actioned the recommendations made by the Uniform Transfers to Minors Act (UTMA), you’re not allowed to open up a UTMA in all states.

By contrast, you’re allowed to set up a UGMA in every state — so no matter where you live, you can start investing in a custodial brokerage account for the kids you love.

How to Choose the Right Custodial Brokerage Account

We’ve covered the different types of custodial brokerage accounts: but how do you choose the right custodial account for you?

When selecting a custodial brokerage account, you must consider your investment style, investment horizon, location, and everything in between.

A lot of account providers will be able to offer either a UGMA or a UTMA account. For most families, the UGMA is ideal — but think hard about what kinds of assets you want to save and how long you want the funds to mature for.

From there, you need to make sure you’re selecting the right stockbroker.

Remember that some brokers will charge administrative fees, setup fees, and high monthly management costs. That means you really need to do your homework. Otherwise, you may end up getting saddled with lots of fees you can’t afford.

For example, there’s no setup fee if you choose EarlyBird to set up a UGMA account. Your first $200 of assets under management (AUM) is totally free. From there, there’s a simple $1 per month subscription fee for each child. Family members, friends, or coworkers can even gift investments to a child’s account for just a $2 gift processing fee.

Next, consider your investment style.

A financial advisor will suggest different account types based on portfolio options — and some options are riskier than others. Bearing that in mind, you’ve got to consider your tolerance and appetite for risk. You need to make sure your custodial account enables you to deploy a basic asset allocation strategy with investment options that you’re comfortable with.

For example, EarlyBird offers you a choice of five different portfolio options designed to cater to all investment styles.

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Conclusion

When it comes to custodial accounts, not every provider or financial institution is created equal. 

That’s why you’ve got to make sure you select an account type and provider that offers the flexibility, simplicity, and price transparency you need to plan for a child’s financial future with confidence.

After all, this is the financial future of the kids in your life — so it’s not something you want to leave to chance. 

Ready to start investing in a child’s financial future? Download the EarlyBird app and set up a custodial brokerage account today.

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