Custodial Accounts are popular as savings tools for children because they may be used for college planning or other uses without an education restriction but can be transferred to a 529 Plan.  Be sure to check out the advantages, disadvantages and other considerations prior to investing.

Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA)

Custodial accounts are another tax-advantaged way to save for college. As custodian for the account, a parent, grandparent, or other adult makes all the investment decisions until the child reaches the age of maturity. UGMA accounts are limited to cash and securities and can hold other types of property.

You may transfer funds from a custodial account tax free to a 529 Plan if the plan accepts such transfers. Transfers must be cash transfers, so you must liquidate any investments you have made and pay taxes, if any, on any gains. There also may be other restrictions and limitations.

For more information visit www.irs.gov.

Advantages

For children younger than 18 - The first $950 in earnings is tax-free. The next $950 in earnings is taxed at the child's federal tax rate in 2010. Any earnings over $1900 are taxed at the custodian's federal tax rate.

See IRS Publication 929 for more details

No contribution or income limitations.

Investment options are virtually limitless

Withdrawals can be used for any purpose without penalty.

Disadvantages

When your child reaches the age of majority, 18 to 25 depending on the state you live in, the child takes over the account and can use the money in the account for anything.

You may not switch beneficiaries because the account is considered the child's asset.

Other Serious Considerations for Custodians/Parents:

Once you fund your child's account the money belongs to the child.  It no longer belongs to you.  You cannot take it back, give it to someone else or change your mind.  It is not "your money."  You cannot take the money out to use for yourself.   You have no "right" to force your child to do with it as you wish.  This may sound brutally redundant but far too many individuals try to use these accounts to avoid taxes and are very upset to learn that they cannot take the money back for themselves.

Once your child reaches the age of majority the account is owned and controlled completely by your child and you have no right to control either the account, the firm that holds the child's account or what the child does with the money involved.  Although you may have wished that the money be used for college tuition your child has the legal right to spend it on a shiny new red sports car or roll the dice and take it to Vegas if he or she wishes.

If this does not sound right for your situation you may wish to consider a 529 College Savings Plan or a Coverdell Education Savings Account for more control.

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