There are all sorts of portfolios that cater to investors’ and consumers’ different needs. If you want to save money for your child’s tuition or future expenses, a custodial stock account offers crucial advantages. Firstly, you start accumulating cash at an early stage. Secondly, you set the objective of your choice, such as college education, an additional source of income, etc. Thirdly, these funds grow over time and make it even more easy to achieve your goals. In addition, you may determine when the beneficiary has access to the account (i.e. at what age).
However, different portfolios have their own characteristics. Because of this, a family that opens the wrong type could end up with extra expenses and unrealized profits. For a start, do you even need a custodial stock account? In some cases, a 529 college fund or an IRA/Roth IRA are better choices. When you consider a custodial account or compare it with other options, there are certain questions that you should ask yourself.
How is a custodial stock account taxed in contrast to the alternatives? What type of investments (stocks, bonds, real estate, etc.) can you utilize? When may you withdraw the money and how easy is it to do so? Above all else, would you benefit if you opened two portfolios at the same time, such as a 529 college fund and a custodial stock account?
Goals and Spending Habits
Whether you want to invest money for tuition expenses, medical costs, or retirement, there are obstacles that you must overcome. They are mostly related to your financial needs and eligibility. This is also important because a custodial stock account beneficiary may spend the funds as they please, without incurring fees on disqualifying purchases.
Moreover, almost anyone can open a custodial stock account. Its eligibility requirements are relatively easy to meet. This is not to say that these portfolios don’t have their own limitations. Instead, your investment objectives and financial plans will define how a custodial stock account fares in comparison to other options.
Firstly, consumers that have a 529 college fund, a 401(k)/IRA, or a health savings account (HSA) may only use their money to pay for certain costs. A 529 fund, for instance, must cover tuition fees, student housing, books, and other specific educational expenses. However, account holders and/or their children cannot use a 529 on student loan payments. In the same vein, IRA and 401(k) owners may withdraw from their portfolios when they reach the retirement age, but not beforehand.
Avoiding Fees and Penalties
HSAs have similar spending restrictions, while flexible spending accounts (FSAs) are even less lenient. For example, what happens to unused FSA funds at the end of the year is out of the owner’s hands. The employee may return them to the account holder, but they could also take the money or cover for other employees’ benefits. Similarly, consumers can’t use an FSA to pay for insurance premiums or non-prescribed medicines.
What happens if they do? The IRS will slap a ten percent penalty. In fact, this even includes leftover 529 funds after your son/daughter graduates. To illustrate, here’s an example: Two parents saved $100,000 in a 529 account by the time that their child turned 18. Initially, their goal was to raise $80,000, which would cover tuition fees, student housing, and transportation costs. However, their investments outperformed expectations and grew their 529 balance to $100,000.
In other words, after paying all of their child’s college expense, the parents had $20,000 left over. If they withdraw the money, the ten percent penalty still applies. That is to say, the account holders will receive $18,000 from the remaining balance. The other $2,000 pays for the fee. A custodial stock account has similar restrictions.
Once a parent or legal guardian makes a deposit, they may not withdraw the funds unless the child reaches the age of maturity. Yet the beneficiary may use their custodial stock account to cover any types of costs, whether they are educational, medical, personal, or a combination of those.
Eligibility Problems
If your household is uncertain about whether or not they will send their children to college, custodial accounts give them room to make a decision. Similarly, consumers who can’t estimate their health care expenses may choose a custodial portfolio, rather than an HSA or FSA, to avoid fees. Above all else, a custodial stock account is ideal when you can’t qualify for other types funds.
To open an HSA, for example, households need to have a minimum annual insurance deductible of $1,350 (individuals) or $2,700 (family plans). Similarly, if your employer doesn’t offer FSA benefits, opening this account type is not an option. Equally as important, the two medical accounts’ rules establish yearly deposit limits and maximums. When your medical expenses exceed this amount, an HSA or FSA, in itself, will not suffice.
IRA and 529 funds are relatively easy to qualify for. However, keep in mind that these accounts also have their own restrictions, especially when it comes to annual deposits or withdrawals. A custodial stock account, on the other hand, is much more lenient.
More Money, More Options
There are additional advantages that a custodial stock account has over its alternatives. Firstly, investors can put their funds in more assets. To clarify, the two main custodial stock account types are UGMA (Unified Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act). UGMAs only allow you to invest your balance in stocks, mutual funds, and bonds. In this respect, UGMA accounts are similar to IRAs, HSAs, and 529 funds.
UTMAs, on the other hand, give you more flexibility. Alongside the financial instruments above, UTMA account holders may also purchase real estate property, patents, and commercial vehicles. Equally as important, with an UGMA custodial stock account, your child assumes ownership of the funds once they turn 18. Meanwhile, UTMAs enable parents to set their daughter or son’s age of eligibility, which can be between 18 and 25.
When we compare the two, UTMAs and UGMAs certainly have their own pros and cons. More specifically, UTMAs are suitable if you prefer to invest in diverse assets. However, parents who prefer to focus on stocks or bonds would benefit from an UGMA, especially when the beneficiary’s age of maturity isn’t an obstacle. Either way, a custodial stock account is advantageous because it gives parents these different choices.
What About Taxes?
Tax deductions and benefits are key concerns amongst investors. This is even more so the case when they compare custodial portfolios to HSAs, FSAs, 529 funds, and/or IRAs, all of which allow you to deduct deposits from your taxable income. Equally as important, you don’t pay taxes on your investment and interest profits. A parent or guardian’s custodial stock account contributions, on other hand, aren’t deductible. Similarly, the child owes taxes when the funds generate revenues.
Usually, the parents file and pay on their behalf. Yet this narrative only takes half of the story into account. Firstly, a household’s medical and educational expenses are tax deductions, regardless of how they pay for them. While you don’t initially deduct the funds when they’re deposited into a custodial stock account, your child certainly does if they spend them on health care or collegiate costs. These deductions also reduce the minor/beneficiary’s taxable investment and interest income.
Secondly, the first $15,000 that each parent deposits into an UGMA account per year is tax free. In contrast, an individual can contribute no more than $2,750, $3,500, and $7,000 into an FSA, HSA, and IRA, respectively. While all of these deposits are deductible, their combined value ($13,250) is still less than the $15,000 gift tax exception that custodial stock account holders enjoy.
Should I open a custodial stock account?
If you want to save money for a child, but without a specific goal in mind, custodial portfolios are more advantageous than the other options. Your daughter or son can use the funds conveniently when they get older and without being constrained by fees or penalties. After that, the beneficiary may deduct medical and educational costs from their taxes. The two custodial stock account types (UGMA and UTMA) allow you to pick the assets that you want to invest in and when the child can access the money.
Parents shouldn’t worry about setting clear financial objectives and deadlines. A custodial account is a great option when you don’t want to commit to an HSA or 529 fund. Above all else, while early savings can lead to sizable profits, a rushed decision could cost you even more in taxes, fees, and penalties.
