4 Things to Watch Out for with Custodial Accounts

Custodial accounts are basically held in trust by trustees or custodians on behalf of the actual beneficiaries. Typically, an account with a bank, mutual fund, or brokerage company can be classified as a custodial account if it is managed by a parent or guardian for the benefit of a child who is still a minor or below the age of 18 or 21 years, as determined by state laws.

When setting up custodial accounts, you must always consider the dollar amount of the accounts that you want to set up. A small account should not cause you any worries, but if you plan to open a big account for your child, you may need to consult a lawyer. Below are the main concerns associated with custodial accounts.

1. Custodial Accounts Can’t be Taken Back

The assets contained in a custodial account with a bank, mutual fund, or brokerage firm will permanently belong to your named beneficiary. This holds true even if your minor child or beneficiary gives permission for the assets in the account to revert back to you. Therefore, make it a point not to include in the custodial account any asset that you may want to take back later on. Also, it is wise to keep the account small, in terms of dollar value.

2. Death of the Beneficiary

In the event that your child or beneficiary dies before reaching the age of majority and the account is fully transferred under his or her name, the manner in which the custodial account passes will be determined by state laws. There may even be complications if your child beneficiary has siblings. Again, making sure that the custodial account you open only has a small dollar amount will give you less worries and more flexibility.

3. The One-Child Policy

A custodial account can belong to only one child or beneficiary. Parents are not allowed to transfer any dollar amount from one custodial account to another. If you have only one child, then you will not have any problems. However, if you have several kids and you want to treat them equally, you need to open custodial accounts for each of them.

The problem with opening several accounts is that most parents can no longer afford to match the amount in the first child’s custodial account such that all their children will have the same asset values in their accounts. To avoid this dilemma, you are better off opening a trust account for all your kids rather than individual custodial accounts.

4. Financial Aid Qualification

Creating a college fund for your child in the form of a custodial account can disqualify him from getting additional financial aid in the future. This is due to the fact that the assets contained in the custodial account will be owned by your child. In most states, the assets owned by a child will weigh heavily when determining the amount and type of financial assistance that he can be entitled to. Having more assets in the child’s name can actually work against him when applying for any financial aid.

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