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What Is a Custodial IRA?

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  • Written By: Kristie Lorette
  • Edited By: O. Wallace
  • Last Modified Date: 14 July 2014
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A custodial IRA is a specific type of investment retirement account. This type of account is established for a minor child by a parent or grandparent. In short, a custodial IRA allows adults to open retirement investment accounts for the benefit of a child.

Similar to a traditional investment retirement account, a custodial IRA establishes an account that allows the money invested today to benefit the child in the future. Investing in this type of account at an early age benefits the child because the money and investments in the account has an extended period of time to grow. Second, it helps the parents to teach their kids about saving and investing money for the future.

As a child starts to work as a teenager and young adult, a custodial IRA account also allows the child to make contributions to the account. This furthers the lessons of saving and investing money. It can also help to teach the child the value of a dollar because they are putting the money they earn to work for them and their future.

When custodial IRAs are established, the child is officially the owner the account and any investments or money the account holds. As the adult, however, the parent or custodian of the account is the manager of the account until the child reaches majority. The age of majority is anywhere from the age of 18 to 21, depending on the state where the account is held.

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The ultimate purpose of a custodial IRA is to save for the child’s retirement. The ways that the child uses the money when they reach the age of majority, however, may change prior to reaching retirement. For one, the child may choose to use some of the funds to pay for their college education. Another allowable use of the funds is to purchase their first home.

Borrowing or withdrawing money from the custodial IRA for qualified purposes, such as education and first-time home buying entitles the child to access the money for their needs. There are also some advantages to taking the money from the IRA rather than traditional borrowing routes. In addition to the use of funds, the custodial IRA possesses a major tax advantage.

The primary tax advantage of this type of IRA is that the interest or growth of the account happens tax-free. The account, the child, and the custodian are not taxed on any growth in the account. In essence, a custodial IRA is tax-free retirement account that a custodian establishes for the benefit of a child. The child benefits from the savings and investments of the account to use toward qualified purposes.

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