Solve Custodial Accounts'Complexities

Physician's Money Digest, June15 2003, Volume 10, Issue 11

Custodial accounts can be avery useful strategy for giftingassets to children andcollege savings, but they are complex,and physician-investors areoften confused about how to usethem. Recently, I wasasked how a parent coulduse excess funds held in 1child's custodial accountfor the education needs ofanother child.


In most states, a minorchild cannot hold title toassets such as stocks,bonds, real estate, CDs,bank accounts, etc, in theirname. Each state allowsyou to set up custodial accountsin the name of anadult, typically a parent, ascustodian for the benefit ofa minor. This custodial accountusually takes 1 of 2forms based on either theUniform Gift to MinorsAct (UGMA) or theUniform Transfer toMinors Act (UTMA).The differencebetween the 2 types of accounts isthat the UTMA allows the custodianto hold a broader range of types ofassets, such as real estate, fine art,patents, and royalties, and also providesfor more flexibility.

One advantage of transferringassets to a child's custodial accountis that income paid on the accountis taxed at the child's tax bracketrather than the parent's tax bracket,which is usually higher. Any gainsrealized due to sale of securitieswould be taxed at the child's taxbracket as well. However, accordingto the "kiddie tax,"for a child whois under age 14, income receivedabove $1500 would be taxed at theparent's highest tax bracket.

Once money has been transferredto a custodial account, it becomesthe property of the child and may notbe diverted for purposes other thanthe benefit of that child. It also cannotbe used to pay for items or servicesthat are considered supportobligations of the parent, such asfood, clothing, and shelter. The custodialfunds could be used for itemssuch as college expenses, expenses ofprivate school, summer camps,autos, etc—although there is somedebate as to whether some of theseitems would also be considered parentalsupport items.


One major pitfall regarding custodialaccounts is that the assetsbecome the property of the childwhen they reach the age of termination.The age of termination varies bystate and by type of custodialaccount. For example,in Alabama, the age of terminationfor a UGMA accountis 19, while it is age21 for the UTMA account.For a state-by-statereview of UGMA andUTMA age of termination,visit Forparents who have beenusing custodian accountsto prefund college costs,you may want to considerrolling those funds over tothe new Section 529 plans.These plans offer significant advantages over custodialaccounts for thispurpose. For more detailson 529 college savingsplans, go to At the bottomof the home page, click on "CoolLinks,"and then click on "InternetGuide to College Savings Plans."

So with all of these rules associatedwith the custodial account,how can you solve the dilemma oftransferring assets from 1 child'scustodial account to the other childwho needed additional funds forcollege? I recommended that thechild make a gift to his sibling forthe needed funds once the child wasof legal age to do so. The parentswould not be able to force the childto do this, but believed that thechild would be agreeable. If the parent,as custodian, had simply withdrawnthe funds and used them forthe other child's benefit, the parentscould end up being subject to IRApenalties and back taxes as well as apossible lawsuit from the child whowas the original beneficiary of thecustodial account.

Stewart H. Welch III,

founder of the Welch

Group, has been rated

one of the nation's top

financial advisors by

Money, Worth, and

Medical Economics. He

is also the coauthor of J.

K. Lasser's New Rules

for Estate and Tax

Planning (John Wiley &

Sons, Inc; 2001). He

welcomes questions or

comments from readers

at 800-709-7100 or

This article was reprinted

with permission

from the Birmingham

Post Herald.