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Whether your niece or nephew is starting their first job or their first day of elementary school, it’s never too early to learn about personal finance. In fact, teaching your nieces and nephews about the value of money will help them for years to come. And there’s no better way to help them prepare for a financially secure future than to help set up their first savings account.

What is a Custodial Savings Account?
A custodial savings account is a savings account that you open in a child’s name. Although they are usually opened by parents saving for their children’s education, custodial savings accounts can be opened for any minor under a custodian’s name. Anyone, including friends, Aunties, and other relatives, can contribute to the account, but the underage child can only withdraw money with the permission of the person who opened the account. There are no limits to the amount of money that can be deposited into a custodial savings account, but amounts more than $12,000 are subject to the gift tax. When the child reaches a certain age (usually 18 or 21), he or she will get full control over the money in the account. While custodial savings accounts are usually opened to set aside money for college, it’s ultimately up to the child to decide what to do with the money once he or she comes of age.

What is So Great About a Custodial Savings Account?
A custodial savings account is as easy to set up as any savings account. Any type of investment can be deposited into the account, including cash, savings bonds and annuities. Unlike 529 plans, which are reserved strictly for college savings, the money accumulated in custodial savings accounts can be used for anything from a new car to a down payment on a first home to a backpacking trip across Europe. Although custodial savings accounts are taxed, they are taxed at the rate of the child’s tax bracket, which is usually lower than the income tax bracket of the adult who opened the account. Custodial savings accounts can also produce tax advantages, since $950 of the investment income (the money you make from interest and other investment earnings) will be tax-free every year.

How Do I Get Started?
Custodial savings accounts can be opened at any bank or even online. Do some research beforehand to find the bank that offers the highest interest rate (read here for more information on high-yield savings accounts and their interest rates) and make sure the bank is FDIC-insured. The minimum amount necessary to open an account will vary depending on the interest rate but usually ranges between $500 and $2,000. To report the interest under your niece’s or nephew’s name, you’ll need his or her Social Security Number. You might want to consider naming a beneficiary for the account, such as a parent, who can take over as custodian of the account in case something happens to you. You can start teaching financial responsibility early on by having children deposit birthday and holiday money into their accounts. They can watch as the $10 Grandma mailed last Christmas grows to finance their college tuition.

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Published: July 19, 2011