How custodial accounts can jump-start your child’s financial future

If you want to invest money for your child’s future, a custodial account may be worth considering. Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) custodial accounts allow an adult (the custodian) to manage money or investments on behalf of a minor (the beneficiary) until the child is legally an adult. While the money legally belongs to the beneficiary, the custodian manages the funds until the child reaches the age of majority, which is defined by state law – usually age 18 or 21. At that point, control of the account transfers fully to the child.

Families use custodial accounts for many reasons: gifting from parents or grandparents, long-term investing or even teaching financial responsibility. In this article, we’ll take a deep dive into how custodial accounts can work to set up your child’s financial future alongside other accounts like 529 plans, Roth IRAs and Trump Accounts.

Why you might want to open a custodial account for your child

The defining feature of a custodial account is ownership: The minor beneficiary is the legal owner of the assets, while the adult custodian simply manages the account until the child reaches the age of majority. This is typically 18 or 21 – although it can be up to age 25 – depending on the state. The structure makes custodial accounts straightforward for gifting; once money is contributed, it becomes an irrevocable gift to the child and cannot be taken back for the adult’s own use.

One of the biggest advantages of custodial accounts is time. For example, if you invested $5,000 in an index fund upon the birth of your child (or grandchild) and that fund had an average annual return of 10% per year, your investment – with no additional contributions – could grow to roughly $37,000 after 21 years. Of course, returns are never guaranteed, and earnings may differ year to year. But that’s the power of compounding. Even modest starting amounts have the potential to grow meaningfully over just a couple of decades.

What can money in a custodial account be used for?

UGMA and UTMA accounts are generally flexible in terms of how the funds can be used as long as the spending benefits the child. Allowable expenses include those relating to education, extracurricular activities, medical treatment or other spending that benefits the minor.

There are some limitations, however. Typically, the custodian cannot use the funds for expenses that are considered the parents’ legal obligation (primarily food, shelter and clothing), although there are exceptions to this. Funds may not be used for expenses related to siblings or anyone other than the designated beneficiary.

This overall flexibility is what distinguishes custodial accounts from 529 plans or other kinds of accounts for minors. A 529 plan is designed specifically for qualified education expenses and offers tax advantages for that purpose. Nonqualified withdrawals from a 529 can trigger taxes and penalties. Custodial accounts, by contrast, can be used for almost any expense that benefits the child; however, they do not offer the same tax-deferred growth or state tax benefits as many 529 plans.

Investment tips for custodial accounts

Time is typically on your side when investing for a child. For long-term goals, you might consider more growth-oriented investments by diversifying into broad market index funds, including mutual funds and ETFs. As the child approaches college age or another life goal for which their custodial account funds can be used, gradually shifting to more conservative investments may help manage risk and protect the gains you’ve already built. As the custodian of the account, it’s your duty to invest the money with the child’s best interests in mind.

Automating contributions can make the process of funding and growing the account easier, helping you build consistency. By automating contributions, you’re also able to take advantage of dollar-cost averaging, which can help smooth market volatility over time. Even with these approaches, it’s still a good idea to review your portfolio annually – and rebalance if necessary to stay aligned with your target allocations and overall investment goals.

Other considerations for custodial accounts

If you’re thinking about opening a custodial account for your child, you’ll want to consider several other factors. Let’s walk through them.

Taxes and gift rules

Custodial account contributions are considered irrevocable gifts to the minor beneficiary. The annual gift tax exclusion – $19,000 for tax year 2026 – shelters the first $19,000 in gifts to each beneficiary each year from any tax consequences. Contributions above the annual exclusion amount may require filing a gift tax return even if no tax is due. Most families will not owe gift tax because of the $15 million lifetime exemption from gift tax for tax year 2026.

Once the funds are invested, interest, dividends and capital gains are generally taxed in the child’s name. Plus, if the unearned income rises above certain thresholds, so-called "kiddie tax" rules can apply; in this case, part of the child’s unearned income is taxed at the parents’ higher marginal rate. Depending on how much the account earns, the child may also need to file a tax return. The custodian is responsible for ensuring proper tax reporting.

Potential impact on college financial aid

When it comes to financial aid, custodial accounts can have a bigger impact than many families expect. Because custodial accounts are owned by the child, they are reported as student assets on the Free Application for Federal Student Aid (FAFSA). Student assets are assessed at a higher rate in the aid formula, which can reduce need-based eligibility more quickly than parent-owned assets. In general, a student is expected to contribute up to 20% of their assets versus 5.64% for parents.

A 529 plan, however, is generally treated differently. For a dependent student, a 529 is typically counted as a parent-owned asset, so it usually has a smaller effect on aid calculations. For those concerned about the greater impact of student-owned assets on financial aid eligibility, one option may be to transfer funds from a custodial brokerage or bank account into a 529 plan. Families pursuing this strategy will want to keep the account titled in the same way to preserve the original ownership structure. Even though the money in the custodial account technically belongs to the student, a custodial 529 account is reported as a parent-owned asset on the FAFSA.

Part of a larger plan

While a custodial account can be a powerful tool, it shouldn’t be the only one in your child’s financial toolkit. Think of it as one part of a larger strategy. A 529 plan, for instance, may make more sense for education-specific savings because of its tax advantages. And once your child begins earning income from a part-time job or summer work, a Roth IRA can be an incredibly effective investment vehicle for the long term.

Trump Accounts are investment accounts for children under age 18 who have a Social Security number. For children born between January 1, 2025, and December 31, 2028, the U.S. Department of the Treasury will even fund the account with a $1,000 “seed” deposit. You can contribute up to $5,000 per year. When your child turns 18, they gain full control and the account is then generally subject to traditional IRA rules.

The goal isn’t to choose one type of account and ignore the rest. Instead, it’s to understand what each tool is designed to do and to use them strategically. A custodial account offers flexibility for general investing and gifting. A 529 plan keeps education savings focused and tax-efficient. Once your child has earned income, a Roth IRA can help build tax-free retirement dollars for decades. And if you open a Trump Account and your child qualifies for the $1,000 government seed deposit, that starting balance can give them an immediate head start, as can other contributions to which they may be entitled (based on ZIP code, a parent’s employer or other factors).

How to open and maintain a custodial account

Opening a custodial account is like opening a savings or brokerage account. The general steps are as follows, though they may differ depending on the institution you decide to use:

Like traditional brokerage accounts, most custodial brokerage accounts offer investment flexibility, with access to stocks, bonds, mutual funds and ETFs. And as with any investment account, you should monitor your portfolio regularly to maintain proper allocation and ensure all tax reporting is handled correctly. Additionally, you’ll want to maintain documentation for withdrawals to show proof of benefit for the child.

When the child reaches the age of majority, as determined by state law and account type, control transfers automatically – your financial institution will require that your child take full ownership, and unless your child authorizes it, you will no longer be able to see or control the account. At that point, the child has full authority over the assets.

The bottom line

Custodial accounts offer flexibility. They allow families to invest for a child’s future while teaching real-world financial skills along the way. These accounts have some nuances, though, so it’s important to understand gifting rules, tax implications and how student-owned assets may one day affect college financial aid eligibility.

For many families, a custodial account can work alongside a 529 plan for education or a Roth IRA once the child starts to earn income. A custodial account could also complement other long-term savings vehicles, such as a Trump Account. Used intentionally, a custodial account can be part of a plan to help young people build both wealth and financial confidence.

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