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Beginner's Guide to UGMA and UTMA Custodial Accounts

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Investment Options and Tax Benefits for Custodial Accounts

Investment Options:

Custodial accounts allow typical stock, bond, and mutual fund investments. Due to their custodial and protective nature, they are not permitted ownership of higher risk investments like stock options or buying on margin.

Tax Benefits:

One of the important misconceptions about these accounts is that they guarantee that you will not pay income tax on a certain amount of dividends, interest, and gains. The reality is, custodial accounts don’t actually grant this privilege, but simply take advantage of it.

Every child under 19 years old (or 24 if a full-time student), who files as part of their parents’ tax return, is allowed a certain amount of “unearned income” at a reduced tax rate. Currently, the first $850 is considered tax-free, and the next $850 is taxed at the child’s bracket (10% for Federal income tax). Anything above those amounts is taxed at the parents’ rate, which may be as high as 35%.

This exemption is per child, not per account. Thus, if the child already has a high level of unearned income (e.g., investment income), opening a custodial may not make a difference.

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