What to Do if Your Child’s Custodial Account is Too Big?

piggy bankCustodial accounts are an easy way to hold money for a minor child’s benefit. They have many advantages.  They’re free-it’s easy to open up a custodial account at any bank or financial services company.  (You’ll know if an account is custodial in California because it will say “CUTMA” on the statement, which stands for California Uniform Transfers to Minors Act.)

They’re simple-a custodial account can hold cash, or other assets, for the benefit of a minor until a certain age (in California, until age 21 if the account is established during life; 25 if created by a Will or a trust after a death). They work as intended – when the property is transferred to the CUTMA account, the child becomes the legal owner, but has no control over the money until the account ends, when they are old enough, presumably, to properly manage it. Until that time, the account’s custodian can use the money for that child’s benefit.

But what do you do if they get too big? I’ve had more than one client come into my office terrified because their children are going to inherit hundreds of thousands of dollars way before their parents think that would be a good idea. Some of you are, no doubt, rolling your eyes in mock horror, but this can be a source of great stress for parents. Imagine, for example, that a well-meaning grandparent bought Pretend Co. stock when it was at $7/share (in 2002) and gave 2000 shares of stock to a custodial account for your child. Fourteen years later, that stock is now worth $104/share and worth $208,000! And your adorable child is now a goofy 17 year old, interested more in texting, dating, and driving than careful investing.

Here’s the legal dilemma–you (the parent/custodian) can’t just withdraw that money, it belongs to  your kid.  You can’t ‘forget about it’ and never let your kid know about their account–that’s lying. So what can you do to try and make sure that this money is carefully invested and responsibly spent?

Here are a few ideas that I’ve discussed with clients over the years:

  1. Spend it. That’s right. Before the account terminates, the custodian can absolutely withdraw money and spend it for the benefit of a minor. So, be creative–spend it for summer camp, adventures around the world, education (at any level from preschool to graduate school), computers, and enrichment activities.
  2. Create a trust with it. Once the account terminates,  you might be able to convince your child that they should work with you and create a trust, with you as Trustee or co-Trustee with your child, and have your child place the money in that trust, which can terminate later, like at 30.  You can’t force a child to withdraw that money and create a trust, though, so this requires cooperation.
  3. Transfer it to a Custodial 529 Account. Before the account terminates, you can, as custodian, transfer the account’s assets to another custodial account. The assets are still ‘owned’ by the minor child after the transfer, but if you transfer the money to a 529 account you are, at least, a bit more able to control how the money will be spent. A 529 account can grow  and be withdrawn free of tax, provided it’s withdrawn for qualified expenses (college and graduate school). Once your child reaches the age that the original CUTMA account terminated, they become the custodian of the account. Until then, the parent, acting as custodian, can use the money for the minor’s benefit.  I think this can be a good solution for many families for several reasons. First, there’s an incentive to use the money for educational expenses. While its true that once the child becomes the custodian they can withdraw the money for non-educational purposes, there is a penalty for doing so, which should at least give them pause. Second, money in a 529 account is counted more favorably under federal financial aid formulas-it is counted as parental money, not the child’s money. Third, if there’s money left over after a child’s education, money in the 529 account can be used for other family member’s educational expenses, provided, of course, that your child has the good sense and generosity that you’ve raised him or her with.

To learn more about custodial 529’s, here are two good resources:

Saving for College.com