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. The first $850 is considered tax-free, and the next $850 is taxed at the child’s bracket (10% for Federal income tax) currently.  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. Any expense that is for the benefit of the child may be paid from the custodial account, at the custodian’s (usually the parent) discretion. Custodial accounts are considered an asset of the child they are set up for, and therefore are counted heavily against financial aid. In any given year, approximately 20% of these assets will be expected to be used towards funding a student’s education. Any adult can set up a custodial account for any child under age 18. There are no contribution limits. However, in one of these accounts someone setting aside money needs to be aware of how larger gifts affect their annual gift tax and lifetime estate tax exclusions.

More about UGMA and UTMA

There is no contribution deadline for custodial accounts. A withdrawal can be initiated by the custodian for the benefit of the child, as long as the expenses are for legitimate needs. Withdrawals are not limited to college costs, and can be used for pre-college educational expenses. Any unused money must be distributed to the child by the time they reach the age of majority or the maximum age allowed for custodial accounts in their state. This is generally age 18 for   classic UGMA accounts. This is usually age 21, but may be as late as age 25 for the newer UTMA accounts. There’s no ability to transfer the account to another child or change beneficiaries unlike Section 529 plans and Coverdell ESA’s. UGMA is an abbreviation for the Uniform Gift to Minor's Act and most often refers to an account set up to hold assets for a minor. Investing through a UGMA account often has a sizable tax benefit over investing in a parent's name. There are strict rules about how the money may be used and at what age it must be completely turned over to the child. UGMA accounts usually have a title the reads something like: John Doe Sr., Custodian for John Doe Jr., under the Uniform Gift to Minor's Act Until Age 18.  UTMA is an abbreviation for the Uniform Transfers to Minor's Act and most often refers to an account set up to hold assets for a minor. UGMA and UTMA accounts were the primary vehicle used by most parents to save for a child's college education for years. UTMA accounts usually have a title the reads something like: John Doe Sr., Custodian for John Doe Jr., under the Uniform Transfer to Minor's Act Until Age 18.