Parents of young children often create custodial accounts, which may be set up under the Uniform Transfer to Minors Act (UTMA), used in most states, or the Uniform Gift to Minors Act (UGMA). There are few differences between UTMA and UGMA accounts: UTMA may permit a wider variety of assets to be held but either account will enable minors to own bank accounts and securities, the most common holdings in custodial accounts.
Compared with other vehicles that permit minors to own assets, such as trusts and guardianships, custodial accounts are simple and inexpensive to create and maintain. In addition, transferring income-producing assets to a child’s custodial account can save taxes, year after year.
Suppose, for example, you and your spouse are in the 28 percent tax bracket. You have $10,000 worth of taxable bond funds yielding 4 percent. These funds generate $400 worth of taxable income each year, and a $112 tax bill, at 28 percent
If you transfer your shares in the bond fund to a custodial account for a child, the income tax bill is transferred as well.
Assuming your child has little or no other investment income, the $400 received from the bond funds will be tax-free.
