What Is a Custodial IRA?

A custodial IRA is an IRA managed by a parent or guardian for the benefit of a minor child, as long as that child works and has earned income. As with other types of IRAs, the maximum annual contribution for 2015 is $5,500 (indexed annually for inflation) and the underlying investments can be determined by the person managing the account, in this case the parent or guardian, prior to the child reaching majority age. A custodial IRA can be either a traditional IRA or a Roth IRA. 

Although an adult typically oversees the account, the funds belong to the minor child and must be turned over at the age of majority, which varies depending on the state. IRAs present tax benefits, and opening an account when a child is relatively young may enhance these advantages. As long as the money remains invested, contributions and investment earnings may potentially compound free of taxation. The longer the time period when contributions are made and the money can compound, the greater is the opportunity to build wealth. Required minimum distributions (RMDs) from traditional IRAs, which are taxed as ordinary income, are mandatory after age 70½. For Roth IRAs, RMDs are not required, and the assets could potentially compound for a lifetime. Restrictions, penalties, and taxes may apply. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.

 

Withdrawals

The objective of an IRA is to save for retirement, but IRS rules permit penalty-free withdrawals for higher education expenses, a first-time home purchase, and other reasons. If your child has a custodial IRA, theoretically he or she could make withdrawals to help further these financial goals without paying a 10% early withdrawal tax. The amount of the withdrawal, however, may be subject to ordinary income taxes unless certain qualifications are met. See IRS Publication 590 for additional information.

It's important to understand that assets within a custodial IRA are considered an irrevocable gift and become the property of the child. A parent or guardian cannot reclaim the assets once the account has been established. Since the assets do belong to the child, the parent or guardian has no control over the child's ability to take non-qualified withdrawals once the child reaches the age of majority.

 

Required Attribution

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content. 

© 2015 Wealth Management Systems Inc. All rights reserved.

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.