Custodial accounts are a powerful financial tool for parents who want to help their children get started on the path to financial success. It enables parents, or other adults, to open up an account on behalf of a child and start investing on behalf of a child at an early age. There are many benefits to opening a custodial account for a child, including financial education opportunities and tax benefits. But, how do you actually open up a custodial account for a child? In this blog post, we’ll review how to open up a custodial account for a child at Charles Schwab.

What is a Custodial Account?

A custodial account is a financial account that is managed by an adult on behalf of a minor, typically a child under the age of 18 or 21 (depending on the state). The adult who manages the account is known as the custodian, and they have the legal authority to manage the funds and investments in the account until the minor reaches the age of majority. Once the minor reaches the age of majority, the funds in the custodial account are legally theirs to control and use as they see fit.

Custodial accounts can be opened at banks, brokerage firms, or other financial institutions, and can hold a variety of assets such as cash, stocks, bonds, and mutual funds. The custodian is responsible for making investment decisions on behalf the minor.

How to Open a Custodial Account at Charles Schwab

To open a custodial account at Charles Schwab, you can follow these steps:

1. Visit the Charles Schwab website and click on the “Open an Account” button.
2. Select “Brokerage Account” as the account type, then scroll down to “Additional Accounts” at the very bottom of the page
3. Under the Educational and Custodial box, select “Custodial Account”
4. This next screen tells you it will take about 10 minutes and you’ll need: U.S. permanent resident address for yourself and the minor, a Social Security Number or Tax Identification Number for yourself and the minor, Employer’s name and mailing address (if applicable) for yourself and the minor.
5. Fill in your personal information – if you have an account most of your information will already be pre-populated.
6. Verify your mailing address.
7. Provide your employment and financials. This will also be pre-populated if you already have an account with Charles Schwab.
8. Answer the standard financial questions such as do you own 10% or more of a public company.
9. Provide the minor’s information including name, date of birth and social security number.
10. Provide the minor’s legal address and phone number – you can click the checkbox up at the top to use the same address and phone number as yours.
11. Provide the minor’s employment status and financial net worth. There is an option to say “not employed” and you can also can put $0 salary and $0 net worth.
12. A screen asking about the state and the age of termination will pop up. Based on the state, the age of termination options will change. For example, some states are age 18, some are age 21, some offer both options and some states offer other ages. You are able to select the age here, and it will tell you what year that is.
13. A screen asks about additional details for the minor, the standard financial questions like if they own 10% of a company.
14. Select what the source of funds will be for this account and the primary purpose of this account.
15. Select if you want checks, options trading and if you want to go paperless.
16. Consent to the terms and conditions and hit submit.
17. The application for a custodial account has now been submitted and you wait for approval or get started on funding the account.

Keep in mind that specific requirements and procedures may vary depending on the state you reside in and the type of custodial account you want to open.

How Do You Transfer Ownership Of A Custodial Account To The Child?

When the child reaches the age of majority, the custodial account will need to be transferred to the child. The account can be transferred into their name only with custodian consent. To do this transfer, contact Charles Schwab, or the brokerage holding the account.

Have you opened a custodial account for your child? What was your experience like?

Opening a custodial account for a child is a smart financial decision that can have many benefits. A custodial account is a type of investment account that allows parents or other adults to invest on behalf of a minor child, who is the beneficiary of the account. This type of account offers many advantages, including the ability to save for the child’s future, teach them about money and investing, and potentially earn tax benefits. In this age of increasing financial uncertainty, opening a custodial account for a child can provide a solid foundation for their financial future. There are also some nuances to be aware of such as potentially impacting future college financial aid and the kiddie tax. In the following paragraphs, we will explore the benefits of a custodial account for a child in more detail.

Custodial Accounts Can Build a Solid Financial Foundation Early

There are many benefits to a custodial account including that it enables a child to build a solid financial foundation early. Instead of family and friends always buying toys, a custodial account enables them to gift money that can be used to buy stocks, ETFs, mutual funds and bonds. Over time this money compounds and can help a child have money to pay for large expenses as the enter adulthood like college, a first car, a first and last payment for their first apartment and more.

Custodial Accounts Teach Children about Money and Investing

A custodial account enables a child to learn about money and investing at an early age. They can be involved in investing decisions as appropriate such as using the money to buy shares in their favorite companies such as Disney. A child can also witness passive income at an early age by seeing their account get dividend payouts. They can also start learning about retirement tools at an early age like Roth IRAs.

Adult Retains Control of The Custodial Account

The account custodian, whether a parent or another adult, has control over the account until the child reaches a certain age. Depending on the state, the custodian will have control either until the child is 18 or 21. The custodian has control to make investment decisions, and can decide how much they want the child to be involved in the investment decisions.

Once the child becomes of age, the funds in the custodial account are legally theirs to control and use as they see fit.

Potential Tax Savings By Opening a Custodial Account

Though a child could end up owing taxes and/or being taxed at the parents’ rate if they make enough unearned income, a custodial account is still a potential way to save money on taxes. If a minor child exceeded the $2,300 annual limit in 2022, they would be taxed at the parents’ tax rate. However, the first $1,150 of unearned income is covered by the kiddie tax’s standard deduction. Therefore, a child would not pay taxes on this first amount. A child who makes $1,150- $2,300 in unearned income like dividends in 2022 will have to file a tax return and will be taxed at the child’s marginal tax rate. Only any amount above $2,300 will be taxed at the parents’ marginal tax rate.

What is the Kiddie Tax?

Before a custodial account is opened for a child, it’s important to become familiar with the kiddie tax. The kiddie tax is a law passed in the US to discourage wealthier individuals from transferring assets to their children to take advantage of their lower tax rates. Current rules tax a minor child’s unearned income like capital gains distributions, dividends and interest incomes at the parents; tax rate if their unearned income exceeds the annual limit. The annual limit in 2022 was $2,300.

The kiddie tax applies to dependent children under the age of 18 and full-time students younger than 24. Learn more about how children are taxed for their unearned income as well as how earned income can impact the taxes they pay see IRS Publication 929 and/or consult your tax advisor.

Custodial Accounts Have Potential Impacts to Financial Aid for College

Even though the custodian retains control of the account until the child is 18 or 21 depending on the state, colleges consider these accounts to be owned by the child. Since the custodial account is considered owned by the child, it could negatively impact the financial aid package from colleges.

Benefits of a Custodial Account for a Child Summary

In summary, there are many benefits of a custodial account for a child. Not only does it allow parents or other adults to save for the child’s future, but it also provides an opportunity to teach them about money management and investing. Additionally, a custodial account can potentially save money on taxes, which can help maximize the amount of money available for the child’s future needs. By starting early and making regular contributions, a custodial account can provide a solid foundation for a child’s financial future and help them build a healthy relationship with money. Overall, a custodial account is a valuable tool for any parent or guardian who wants to ensure their child’s financial well-being.