These accounts aren't for everyone. Here are the pros and cons.
Custodial accounts allow you to give money to children but retain control over the funds until they reach the age of majority, either 18 or 21 depending on their state of residence.
Ease of use and low cost make them the ideal receptacle for small cash gifts (say, less than $11,000) from those other than parents. Just about all the giver needs to do is write a check and set up an account under the Uniform Gifts to Minors Act.
You'd also be sensible to choose a custodial account if it's only to last a short time. Say your 17-year-old nephew is headed for college. Then a custodial account may be the perfect place to set aside a year or more of tuition. Keep in mind the likelihood of what you're planning for, though. Is he really headed for college?
Setting up a substantial custodial account is least appropriate when a child is very young. Even assuming the child is likely to go to college, this isn't enough to support putting a large sum irrevocably out of your reach.
Any number of things can go wrong: the child could develop drug problems, be involved in a religious cult, or simply be financially irresponsible. Once he reaches adulthood, the child can throw away the entire fund and you could do nothing about it. Or he could develop a serious medical problem, and the custodial account may prevent him from qualifying for supplemental Social Security income.
Other problems having nothing to do with the child could develop. One doctor contributed money to a custodial account for her son every year. A divorce order required her to pay for the child's support and education, but when she tried to take money out of the custodial account for this purpose, the court said the funds belonged to the son. The doctor couldn't use the money in the custodial account to satisfy her legal obligation.
There's also a tax issue to consider: If the child is under the age of 14, "kiddie" tax rules apply, whereby income above a certain level can be taxed at the parent's higher rate. If you're saving primarily for future education, Section 529 plans or a Coverdell Education Savings Account may be a better bet.
Don't rule custodial accounts out, but remember that they're not always the perfect choice for gift-giving. Before setting up an account, consider all the possibilities that the future may hold for your family.
Vicki Brentnall. When a custodial account makes sense. Medical Economics Sep. 5, 2003;80:52.