Personal Finance: Control of custodial account shifts at 21

Personal Finance: Control of custodial account shifts at 21

April 6th, 2011 by By Chris Hopkins in Business Diary

Saving for college expenses is an important priority for many parents, best begun as soon as possible considering the accelerating costs of tuition. Custodial accounts have traditionally been a favored mechanism for establishing a segregated fund designated for future educational or other financial needs of minor children. However, this type of account carries potential drawbacks and should be thoroughly understood before being funded.

When referring to a custodial account, we generally mean an account established under the Uniform Transfer to Minors Act, or UTMA. These arrangements allow parents, grandparents or others to segregate assets in the name and title of a minor child. The transfer of assets is irrevocable, and the account is managed by the named adult custodian (typically a parent). Any disbursements must be made for the benefit of the child.

The advantages of UTMA accounts include the legal separation of the assets held therein from the estate of the donor, as well as the likelihood of reduced taxes on the earnings of the account, since the minor child's tax rates are usually lower.

However, one major feature of the UTMA account should be clearly understood before proceeding. Since the assets belong to the child, they will be accessible without restriction to that child upon reaching majority (age 21, or in some states younger).

Many banks and brokerages freeze the account on the appropriate birthday, accepting no further instructions from the custodian and effectively handing over the bank book to the beneficiary.

While some 21-year-olds (or 18-year-olds in some states) are mature enough to handle such a windfall, this is clearly not always the case. If the sum involved is substantial, it may be wise to consider other vehicles that avoid a large distribution to the beneficiary at a relatively young age.

Section 529 education plans are an excellent choice for college funding. The named trustee retains control of disbursements, and assets left over after graduation may be redirected to fund college expenses of other family members.

In some cases involving large amounts, a trust may be appropriate. Trusts are more complex and expensive, but can specify extended control of assets by the trustee, and can be tailored to a wide variety of objectives and special needs including, but not restricted to, education.

Traditional UTMA accounts may still suffice in some instances, but be sure to consider alternatives that retain more control if the amount involved is considerable.

Chris Hopkins is a certified financial analyst and vice president of investments at Barnett & Co. Inc. Submit questions to his attention to Business Editor Dave Flessner at