one thing to be aware of is The Kiddie Tax. Basically applies when a child dependent is not over 23 and has unearned income over a certain threshold that changes from year to year.
for 2025
child has unearned income only
$0-$1,350 - not taxed
$1351-$2,700 - tax at child's rate
over $2,700 parebt's rate or child's rate if higher
parnet(s) can choose
a) Form 8615 - child files own return
b) Form 8814 - included on parent(s) return
there are cons to a custodial account so here are some things that should be considered
Cons: Drawbacks of Custodial Accounts
Loss of Control Upon Reaching Legal Age: A major downside of custodial accounts is the custodian loses authority over the account once the child reaches the legal age of majority. At this point, the child can access and use the funds however they wish, regardless of the original purpose for which the account was set up.
This loss of oversight can be concerning for those hoping to ensure the funds are spent wisely.
Impact on Financial Aid: Custodial accounts are considered the child’s asset when applying for financial aid, which can significantly reduce eligibility for need-based assistance. This can be an issue for families planning to use financial aid to fund a child’s college education.
Risk of Tax Implications on Gains: While custodial accounts offer some tax advantages, they can also result in hefty tax bills. Once a child’s unearned income surpasses a certain amount for the year, it is subject to the “kiddie tax,” which taxes income at the parent’s rate, potentially leading to high tax liabilities.
Irrevocable Nature of Gifts: Once assets are deposited into a custodial account, they are considered a permanent gift to the child and cannot be reversed. This can be problematic if the custodian faces unforeseen financial challenges.
Limited Investment Options with Certain Providers: While custodial accounts typically offer a broad range of investments, some providers may restrict the types of assets available for inclusion in the account. This could limit the custodian’s ability to diversify or tailor the investment strategy.
State-Specific Regulations: Custodial accounts are governed by the laws of the state in which they are opened, and these regulations can vary widely. This can create complications, especially for families that move between states or have assets in multiple jurisdictions.
Potential Mismanagement by the Child: Once the child gains full control of the custodial account at adulthood, there is the risk that they may mismanage the funds. Lack of experience with financial management can lead to poor decisions or unnecessary spending.
No Immediate Tax Deductions for Contributions - Gift Tax Return: Unlike other savings vehicles like IRAs or 529 plans, contributions to a custodial account are not tax-deductible. While the account may offer tax benefits on the earnings, there is no immediate tax relief for those who fund the account. If gifts to the child, including assets put into a custodial account, exceed $19,000 for 2025, a Gift Tax Return, Form 709 is required
Impact on Eligibility for Government Assistance: A significant custodial account balance may affect a child’s eligibility for government benefits like Medicaid or Supplemental Security Income (SSI). Since the funds are considered the child’s property upon reaching adulthood, the assets could disqualify the child from receiving certain forms of aid.
Estate Tax Considerations: If the custodian passes away before the beneficiary reaches the age of majority, the account’s assets may be included in the custodian’s taxable estate, potentially increasing estate tax obligations.
Complexity in Tax Reporting: Managing the tax implications of custodial accounts can be complex, requiring careful planning to navigate the “kiddie tax” rules and potential tax liabilities.
Potential for Lawsuit: Depending on state law, should the account be mismanaged, the beneficiary may have a right to sue the custodian
