Custodial account

A custodial account is a financial account (such as a bank account, a trust fund or a brokerage account) set up for the benefit of a beneficiary, and administered by a responsible person, known as a legal guardian or custodian, who has a fiduciary obligation to the beneficiary.

Custodial accounts come in a number of forms, one being an account set up for a minor, since the minor is under the legal age of majority. The custodian is often the minor's parent. In the U.S., this type of account is often structured as a Coverdell ESA, allowing for tax-advantaged treatment of educational expenses. Another form is a trust account owned by an individual or institution, managed by a named party for purposes of rapid distribution of funds in that account. This is commonly used for petty cash, or for transactions that have very limited and clearly defined payees and transaction types. For example, law firm accounting includes trust accounts for disbursing funds entrusted to the law firm by each client for the client's benefit.

Minors

In the United States, the Uniform Transfers to Minors Act provides for the possibility of bank accounts, brokerage accounts, and other property to be held in a custodial capacity under the Act so that the custodian has the right to control the property but that legal title is deemed to be in the minor for many purposes.

Securities custodianship

In the United States Brokerage account agreements under Article 8 of the Uniform Commercial Code create a legal relation known as "custodianship", which is distinguished from the traditional concept of a trust.

For example, in the context of the Individual Retirement Account (IRA), a brokerage firm distinguishes its custodial account IRAs from trust IRAs when seeking IRS tax approval for an IRA plan which is part of a brokerage account agreement. The treatment of a brokerage account based IRA as a trust for tax purposes is largely a legal fiction.

If Article 8 is set aside and the brokerage account is considered purely under principles of common law, there is a possibility of construing the collection of brokerage accounts in the intermediated custodial holding chain as a collection of directed agency nominee trusts. According to this legal theory, each securities position with respect to a particular class of securities which appears in the brokerage firm's omnibus securities account is a trust fund for the benefit of customers sharing participation in that position. To exactly what extent the operation of such a theory would be restricted by Article 8 and the Securities Investor Protection Act in future litigation is not obvious, and is perhaps irrelevant as a practical matter because of the level of detail in the legislation mentioned.

The trustee of a nominee trust, being a directed agent of the beneficiaries, cannot even bind the trust estate to a debt in a capacity that is sufficiently separate from the capacity of the beneficiaries to contract the same debt themselves. For this reason, the nominee trust is not a debtor-person for bankruptcy purposes and therefore cannot obtain bankruptcy protection like it were a corporation. This is one reason why nominee trusts are not considered to be actual trusts by some lawyers.

In the United Kingdom, principles of common law operate with greater freedom in relation securities custody. A securities intermediary is naturally characterized as a trustee for the benefit of clients holding interests in those securities.

Advantages

Custodial accounts offer tremendous flexibility. There are no income or contribution limits or requirements for regular distributions at any time. There are also no penalties for withdrawals.

While all funds withdrawn may only be used "for the benefit of the minor," this requirement is vague and not limited to educational expenses as in the case of college savings plans. The custodian can use the funds for anything from providing housing or paying for clothing, as long as the beneficiary receives a benefit.

It is much easier and cheaper to set up a custodial account than a trust fund. The purpose of the UGMA and UTMA rules was to allow adults to transfer assets to minors without the need to create a special trust account to secure such ownership. The documents required to open a trust account depend on the specific financial institution.

Disadvantages

Ownership of a custodial account by a minor can be a two-pronged stick. Because assets are considered assets, they may reduce a child's eligibility for college financial aid.

It may also limit their ability to access other forms of government or public assistance.

Custodial accounts are not as tax sheltered as other accounts. To reduce tax benefits, a custodian can roll over funds into an eligible 529 plan. However, in order to do so, the custodian must liquidate any non-cash investments in the custodial account.

In addition, the beneficiary of a custodial account cannot be changed, while the beneficiary under a 529 college plan can change with certain restrictions. A custodial account is opened in the name of a minor. Because the account is irrevocable, the beneficiary of the account cannot change, and no gifts or contributions made to the account can be canceled.

See also

• Trust law
• Custodian bank
• Segregated account
• Securities account