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Answers to questions about how custodial accounts may be used.
I get questions from time to time about what are proper uses of custodial assets. Can I buy a car for my child? A computer? Can I use money in the custodial account to pay taxes on the earnings of the account? Where do you draw the line?
The starting point is section 14(a) of the Uniform Transfers to Minors Act, which says:
A custodian may deliver or pay to the minor or expend for the minor's benefit so much of the custodial property as the custodian considers advisable for the use and benefit of the minor, without court order and without regard to (i) the duty or ability of the custodian personally or of any other person to support the minor, or (ii) any other income or property of the minor which may be applicable or available for that purpose.
That's a pretty liberal standard! An earlier version of the Act contained the words, "for the support, maintenance, education and benefit of the minor." The current version, which is in effect in nearly all states, uses the more generous words, "for the use and benefit of the minor." Official commentary on the Act says this change was "intended to avoid the implication that the custodial property can be used only for the required support of the minor."
Note: As custodian, you're supposed to be able to account for where the money went. If you pulled money from the account to buy a computer for your child, make a permanent record of this fact.
Many people have the mistaken impression that you can't use a custodial account for items that a parent is required to provide as support for the child. Click here for discussion of this issue.
Costs of education. Of course you can use these accounts to pay for the child's education. That's probably the biggest single use. For reasons explained elsewhere, I don't think this is a good way to save for college, but if you want to use a custodial account for college costs (or costs of primary or secondary education) that's clearly proper.
Car for the child. Why not? It's an expenditure for the benefit of the child.
Paying taxes on the account's income. The child owns the account, and is liable for the tax on any income the account generates. Since the child owes the tax, a payment from the account to pay the tax is a payment for the benefit of the child.
Transfer to another child. Sometimes one child ends up with an account that's larger than the parent can provide for a sibling, due to a later start or a difference in the way the account was invested. Can you make a transfer from one account to the other to "even things up"? As a parent I sympathize with the motive, but I can't see how that's proper under the Act. The child with the larger account owns that account. Taking money from that account to transfer to a sibling's account may, in some philosophical way, be for the benefit of both children, but I believe the Act requires a more direct benefit to the child who owns the account.
Paying family expenses. You can get into some tough issues here. Suppose tapping the account is the only way the parent can afford to live in a nice neighborhood. And the reason the parent wants to live in the nice neighborhood is better schools and environment for the child. Can you charge rent from the child and pay it from the account? Use the account for part of the down payment on a home? If push came to shove I would probably have to say these types of expenditure are improper (legally, not necessarily morally), but others might disagree.
Suppose you have expenditures that would be clearly proper for a custodial account, but they occurred in the past. Can you use the account to reimburse the parent for past expenses? There's nothing in the Uniform Act explicitly addressing this issue. The general standard set forth above requires the custodian to use the account for the benefit of the child, however, and reimbursing past expenditures that were incurred by a parent or other person is not for the benefit of the child. It should be acceptable to reimburse recent expenses that were incurred with an expectation of reimbursement; for example, the custodian might agree to use part of the account to buy an auto for the minor, advance money for the purchase from the custodian's account and then seek reimbursement from the custodial account. If the custodian does not seek reimbursement promptly after incurring the expenditure, however, the natural inference would be that the custodian made a gift at the time the expenditure was made, and is now recovering the gift from the custodial account, which would be an improper use of the account.
As noted above, there are some gray areas surrounding this question. Yet few people will go wrong if they keep in mind the basic standard: the expenditures must be for the benefit of the child.
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