What Is a Custodial Account?
Accounts under the Uniform Transfers to Minors Act, known as UTMA, and the Uniform Gifts to Minors Act, known as UGMA, are custodial accounts that allow for the transfer of funds, securities and other assets to minors without the need for a formal trust. Regulatory Notice 20-07 of the Financial Industry Regulatory Authority, known as FINRA, refers to them collectively as UTMA/UGMA Accounts.
UGMA and UTMA
UGMA and UTMA are model laws developed and approved by the Uniform Law Commission. Every state has adopted some version of either UGMA or UTMA through its state legislature to allow for the establishment of UTMA/UGMA Accounts. While the specific requirements for UTMA/UGMA Accounts vary from state to state, the accounts share common characteristics. The law varies by state: one state may allow UTMA accounts while another allows UGMA accounts.
UGMA and UTMA accounts are largely the same, but the kind of assets that can be contributed to them differs. UGMA accounts are limited to gifts of cash, securities such as stocks, bonds or mutual funds, and insurance policies. UTMA accounts allow for the contribution of virtually any kind of asset, including real estate.
These accounts can be set up at almost any brokerage firm, mutual fund company or other financial institution.
Donor, Custodian and Beneficiary
Generally, when UTMA/UGMA Accounts are established, the donor appoints a custodian, designates a minor beneficiary and deposits assets into the account. Depositing assets into a UTMA/UGMA Account represents an irrevocable transfer from the donor to the beneficiary.
Generally, when UTMA or UGMA accounts are established, the beneficiary, who is a minor, becomes the owner of the property at the time of the gift. The custodian manages and invests the property on the beneficiary's behalf until the beneficiary reaches the age of majority, at which point the custodian is required to transfer the custodial property to the beneficiary.
The custodian is responsible for managing the assets in the UTMA/UGMA Account, including executing transactions and withdrawing or transferring funds, for the benefit of the beneficiary until the custodianship terminates. Like a Coverdell ESA, with a UGMA or UTMA account a parent, grandparent or other adult is custodian for the account and makes all the investment decisions until the account beneficiary reaches the age of majority.
What One State's Uniform Act Provides
The Nevada Revised Statutes, known as NRS, include Chapter 167, titled Transfers to Minors (Uniform Act), which may be cited as Nevada's Uniform Act on Transfers to Minors. NRS 167.020 defines a custodian as a person so designated in a manner prescribed in the chapter, a term that includes a successor or substitute custodian. It defines custodial property as any interest in property transferred to a custodian in a manner prescribed in the chapter, together with the income from and the proceeds of that interest in property. It defines a minor as a person who has not attained the age of 18 years.
NRS 167.030(3) provides that a transfer made in a manner prescribed in subsection 1 may be made to only one minor and only one person may be the custodian. It adds that any custodial property held by the same custodian for the benefit of the same minor constitutes a single custodianship.
NRS 167.040(1) provides that a transfer made in a manner prescribed in the chapter is irrevocable and conveys to the minor indefeasibly vested legal title to the custodial property, but the custodian has any right, power, duty or authority provided in the chapter and neither the minor nor the minor's legal representative has any right, power, duty or authority with respect to the custodial property except as provided in the chapter.
NRS 167.050(1) provides that the custodian shall take control of the custodial property, register or record title to the custodial property if appropriate, and collect, hold, manage, invest and reinvest the custodial property. Under NRS 167.050(2), in dealing with custodial property the custodian shall observe the standard of care that would be observed by a prudent person dealing with property of another, and is not limited by any other statute restricting investments by fiduciaries. If the custodian has a special skill or expertise or is named custodian on the basis of representations of a special skill or expertise, he or she shall use that skill or expertise. However, the custodian, without liability to the minor or the minor's estate, may retain any custodial property received from a transferor.
NRS 167.055(1) provides that a custodian may deliver or pay to the minor or expend for the minor's benefit so much of the custodial property as the custodian considers advisable for the use and benefit of the minor, without court order and without regard to the duty or ability of the custodian personally or of any other person to support the minor, or to any other income or property of the minor which may be applicable or available for that purpose. Under NRS 167.060(1), a custodian is entitled to reimbursement from the custodial property for reasonable expenses incurred in the performance of the custodian's duties.
NRS 167.095(1) provides that the custodian shall transfer in an appropriate manner the custodial property to the minor or to the minor's estate upon the earlier of the events listed in the subsection.
These sections show how one state's enactment treats the points above. They do not replace the law of any other state.
Uses of a Custodial Account
While not solely intended for college savings, UGMA or UTMA custodial accounts can also offer an avenue to save for education. These custodial accounts transfer assets to the child at the age of majority, which differs by state, and the assets can be used for any purpose.
If a child has earned income, a designated adult can open a custodial individual retirement account on the child's behalf. The designated adult controls the account until the child reaches the age of majority, which varies by state. Contributions cannot exceed the amount the child earns each year.
When the Custodianship Ends
The custodianship generally terminates when the beneficiary reaches the age of majority, reaches an alternative age of termination set forth in the relevant state statute, or dies. Some state laws also permit extending the custodianship to a higher specified age by the donor when establishing the custodianship or by the custodian, provided that the beneficiary receives notification of his or her right to compel distribution of the assets upon reaching a specified age.
FINRA's notice refers to the termination of the custodianship upon the beneficiary reaching the relevant age. Unless the custodianship has been extended or the custodian has been granted continuing authority over the assets in the UTMA/UGMA Account, such as through a power of attorney, generally the custodian does not have authority over the assets in the UTMA/UGMA Account after the beneficiary reaches the relevant age.
Know Your Customer and Supervision
FINRA Rule 2090 requires every member to use reasonable diligence, in regard to the opening and maintenance of every account, to know and retain the essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer. Under Supplementary Material .01, facts essential to knowing the customer are those required to effectively service the customer's account, act in accordance with any special handling instructions for the account, understand the authority of each person acting on behalf of the customer, and comply with applicable laws, regulations, and rules.
Regulatory Notice 11-02 advised that firms verify the essential facts about a customer at intervals reasonably calculated to prevent and detect any mishandling of a customer's account that might result from the customer's change in circumstances.
FINRA Rule 3110(a) provides that each member shall establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules. Accordingly, a member firm is required to establish, maintain and enforce a supervisory system reasonably designed to achieve compliance with its continuing obligation to know the essential facts of all customers, including UTMA/UGMA Account customers.
The termination of the custodianship, whether due to the beneficiary reaching the relevant age or dying, represents an important change in the customer relationship and is an essential fact about the UTMA/UGMA Account customer that member firms and their associated persons should know pursuant to the requirements of Rule 2090. Failure to have a reasonably designed supervisory system in place pursuant to Rule 3110 that takes into account the termination of the custodianship, and the changed authority resulting from that termination, may result in a mishandling of the UTMA/UGMA Account.
What FINRA Found
FINRA's examination program has found member firms that have effective supervisory systems and procedures for UTMA/UGMA Accounts. FINRA has also found that some member firms permitted customers to open UTMA/UGMA Accounts, yet failed to have reasonably designed systems and procedures to supervise UTMA/UGMA Accounts, including reasonable diligence procedures to determine the authority over those accounts in and around the time the beneficiary reaches the relevant age.
FINRA found that many firms were aware of the need to transfer responsibility for the account at a future date because they had policies and procedures addressing this topic, such as noting the date of majority when setting up the account. However, some firms did not take any steps to track or monitor when beneficiaries would reach the age of majority, while other firms had procedures for their registered representatives to follow but did not require any supervisory oversight.
In some instances, firms permitted custodians to effect transactions in, and withdraw, journal and transfer money from UTMA/UGMA Accounts months, or even years, after the beneficiaries reached the age of majority, and ignored red flags of such activity, such as customer complaints relating to such transactions.
What FINRA Expects of Firms
To know the essential facts about the UTMA/UGMA Account customer as required by Rule 2090, and to fulfill requirements under Rule 3110, member firms with UTMA/UGMA Account customers should have a supervisory system and procedures in place that are reasonably designed to address the termination of the custodianship upon the beneficiary reaching the relevant age, and to verify whether the custodian has authority to manage assets in the UTMA/UGMA Account after the beneficiary reaches the relevant age.
Member firms have flexibility in designing the supervisory system and procedures based on size and business model, but FINRA expects member firms to take into account the relevant age when establishing a UTMA/UGMA Account and take steps to track or monitor when the beneficiary reaches the relevant age. FINRA expects member firms to take steps to verify whether the custodian has authority to manage assets in the UTMA/UGMA Account after the beneficiary reaches the relevant age, such as communicating with the custodian and any assigned registered representative in advance of the beneficiary reaching the relevant age. Failure to so verify may result in improperly permitting the custodian to manage assets in the UTMA/UGMA Account.
Some firms implemented a number of effective practices for verifying the authority of custodians of UTMA/UGMA Accounts. Some firms maintained supervisory systems and used automated tools to track when each UTMA/UGMA Account beneficiary reached the age of majority. Some firms issued letters or provided notifications to custodians to advise them that beneficiaries were approaching the age of majority and informed them about upcoming transfers of custodial property in their UTMA/UGMA Accounts, as well as any restrictions to the custodians' trading authority after the beneficiaries reached the age of majority. Some firms maintained systems to provide registered representatives with automated alerts when beneficiaries reached the age of majority and required them to communicate with the custodian about the transfer of custodial property.
Customer Account Information
FINRA Rule 4512(a)(1) requires, for each account, the customer's name and residence, and whether the customer is of legal age. Among other items, the rule also requires the names of the associated persons, if any, responsible for the account, the signature of the partner, officer or manager denoting that the account has been accepted in accordance with the member's policies and procedures for acceptance of accounts, and, subject to Supplementary Material .06, the name of and contact information for a trusted contact person age 18 or older who may be contacted about the customer's account.
Custodial Account on the Examination
The content outline for the Securities Industry Essentials examination lists customer account registrations under Topic 3.2.2 in Section 3, Understanding Trading, Customer Accounts and Prohibited Activities. The registrations listed there are individual, joint, corporate/institutional, trust with revocable and irrevocable named in parentheses, custodial with UTMA named in parentheses, partnerships, and retirement. The Rules list in Section 3 includes FINRA Rule 2090 on Know Your Customer and FINRA Rule 4512 on Customer Account Information. Candidates should check the current outline before the examination.
Common Misunderstandings
The donor can take the gift back. Depositing assets into a UTMA/UGMA Account represents an irrevocable transfer from the donor to the beneficiary.
The custodian owns the account. The beneficiary, who is a minor, generally becomes the owner of the property at the time of the gift, and the custodian manages and invests the property on the beneficiary's behalf.
The custodian keeps control after the beneficiary reaches the age of majority. The custodianship generally terminates when the beneficiary reaches the age of majority, reaches an alternative age of termination set forth in the relevant state statute, or dies, and generally the custodian does not have authority over the assets after the beneficiary reaches the relevant age unless the custodianship has been extended or the custodian has been granted continuing authority over the assets.
UGMA and UTMA accounts accept the same assets. UGMA accounts are limited to gifts of cash, securities and insurance policies, and UTMA accounts allow for the contribution of virtually any kind of asset, including real estate.
The age of majority is the same everywhere. The age of majority differs by state, and the requirements for UTMA/UGMA Accounts vary from state to state.
A trust must be created for the account. UTMA/UGMA Accounts allow for the transfer of funds, securities and other assets to minors without the need for a formal trust.
Key Points
A custodial account under UGMA or UTMA allows for the transfer of funds, securities and other assets to a minor without the need for a formal trust.
The donor appoints a custodian, designates a minor beneficiary and deposits assets into the account, and the deposit is an irrevocable transfer to the beneficiary.
The beneficiary generally becomes the owner of the property at the time of the gift, and the custodian manages and invests it until the custodianship terminates.
UGMA accounts are limited to gifts of cash, securities and insurance policies, and UTMA accounts allow virtually any kind of asset, including real estate.
The custodianship generally terminates when the beneficiary reaches the age of majority, reaches an alternative age of termination set in the state statute, or dies.
FINRA expects member firms to track when the beneficiary reaches the relevant age and to verify whether the custodian has authority to manage assets after that age.
