What Is a Custodial Account and How Does It Work?

When you are painting the financial picture for your family, whether it is investing in real estate, brokerage accounts or even just an emergency fund, the money saved and earned isn’t just about you. Teaching your children about the hows and whys of personal banking is a crucial part of them becoming financially literate and independent.

Read: How To Guard Your Wealth From a Potential Banking Crisis With Gold

What Is a Custodial Account?

Setting up a custodial account puts you, as the parent, in control of the account until the child is 18. That means you make all the deposits and your withdrawals must be to cover expenses relating to your child’s well-being. Though custodial accounts are more to set up a nest egg for your child to use when they become an adult, qualifying expenses include things such as:

• Education expense

• School supplies

• Braces

• Other financial aid that benefits your child

How a Custodial Account Works

Opening a bank account for your child can be a great opportunity to teach them about financial literacy. It gives kids a look at what a bank’s function is, and enables them to set monetary goals, then budget based on what they want to obtain. Though there are many reasons and tax advantages for a child to have a bank account, minors can’t open an account without a parent or guardian listed as a joint owner.

Pros and Cons of Custodial Accounts

Here are some pros and cons of custodial accounts to consider.

Pros

• Easy to open and monitor

• No contribution limits

Cons

• Funds only pass to the child upon the age of majority

• Fewer tax advantages than other accounts

6 Steps To Opening a Custodial Account

No matter the type of custodial account you open, have your child set financial goals These goals could be things like saving to buy something they want such as toys, clothes or even real estate. You can also ask them to set aside a certain amount to help with college, or something else in the future to give them a sense of short-term savings goals versus long-term savings goals.

Here are six steps to follow to open a custodial account:

• Step 1: Choose an account type

• Step 2: Find the best option

• Step 3: Apply for the account

• Step 4: Activate the debit card

• Step 5: Download the app

• Step 6: Fund it

Step 1: Choose an Account Type

There are three basic account types you’ll be considering for your child: joint, custodial and prepaid. A joint account is similar to one you would have with a spouse or business partner. Both you and your child will have access to the account to deposit and withdraw. Here are some key takeaways:

• You should consider a checking account so you can make frequent withdrawals.

• Open a savings account if you’re more focused on storing money that your child can access when he or she is older.

• If your child is a teenager and has a job, they can contribute their own money.

• The prepaid option refers to giving your kids a prepaid debit card that you load with cash.

• Though a joint checking account will typically have a debit card, the prepaid debit card is better for young children who might not have a way of earning money yet.

Step 2: Find the Best Option

The easiest place to open an account for your child would be at the bank you use. Check to see what their policies and offerings are for kids’ accounts and if those seem like they would be what you’re looking for. Some factors to consider before opening an account would be:

• How much a bank offers in terms of savings account yield.

• How much oversight a child has over their account.

• Any tools that go along with the account.

There are tons of options out there for you to choose from when it comes to banking for your kids, so make sure you look into everything available.

Step 3: Apply for an Account

Once you’ve made a decision, you can apply. You’ll usually need identifying documents for both you and your child, like your driver’s license and your child’s birth certificate. Most application processes are pretty quick and painless, and you should have the account the same day you apply.

Step 4: Activate the Debit Card

If you applied for an account that comes with a debit card, make sure you activate it as soon as it arrives so your child can start using it. Better yet, have them go through the activation process so they learn how to do it in the future.

Step 5: Download the App

Whether it’s your bank’s app or another app, you’ll need to download it and register to track your child’s spending. Take the time to learn its functionalities so you can make the most of your child’s new account. If they have a device it is a great option for you both to have the app so you can jointly monitor the account.

Step 6: Fund It

If you’re the primary funder, go ahead and deposit some cash so your child can start managing the cash. If your child has a job, have them ask their employer how they can set up direct deposit so they can start regularly using their account for everyday expenses.

Final Take To GO

Custodial accounts have a purpose so make sure you and your child understand the rules of the account. Whether you are opening it to get a child tax rate or gift tax return, having children learn about the importance of budgeting their money isn’t something they can learn too soon.

FAQ

Here are the answers to some of the most frequently asked questions regarding custodial accounts.

• Are custodial accounts a good idea?

  • Yes, custodial accounts are a great way to teach a minor about money and have them be in charge, with your help, of their finances. Here are some things to know:

    • Custodial checking accounts allow you to make frequent withdrawals.

    • Custodial savings accounts are more focused on storing money that your child can access when he or she is older.

    • It's a good option if your child is a teenager and has a job where they can contribute their own money.

• What is better: a 529 account or a custodial account?

  • Though both have merit, a 529 plan is a college savings plan sponsored by a state or state agency, so will not necessarily be as easy to open as a regular custodial account.

• Can a parent take money from a custodial account?

  • No, any money, even if you're the one who has contributed it, is your child's. Once the money has been deposited, it will belong to the account holder, which is your child.

• What are the cons of a custodial account?

  • Some cons of custodial accounts that you should consider are:

    • The funds will only pass to the child upon the age of majority

    • Fewer tax advantages than other accounts

Sam DiSalvo contributed to the reporting for this article.

This article originally appeared on GOBankingRates.com: What Is a Custodial Account and How Does It Work?