Minors

What Is Minors in Finance?

In finance, "minors" refers to individuals who have not yet reached the age of majority, the legal threshold at which a person is considered an adult and can enter into binding contracts. This age varies by state in the United States, typically ranging from 18 to 21 years old. Due to their limited legal capacity, minors generally cannot directly own or manage certain financial assets or open a brokerage account in their own name. This legal framework falls under the broader category of personal finance and investment accounts, specifically addressing how assets can be held and managed for the benefit of someone under the age of legal adulthood.

Because minors are not legally empowered to manage significant financial dealings, specialized structures are necessary to facilitate savings and investments made on their behalf. The most common of these are custodial accounts, which allow an adult to manage assets for the minor until they reach the age of majority or a specified age for account termination.

History and Origin

Historically, the common law age of majority for contractual capacity was 21 for centuries. This standard was largely rooted in English common law, which influenced legal systems in the United States. However, significant changes occurred in the late 1960s and early 1970s. As 18-year-olds were being drafted to serve in the military during the Vietnam War, a movement gained traction advocating for the alignment of voting age, military service age, and the age of majority. This led to the ratification of the 26th Amendment in 1971, lowering the voting age to 18. Following this, many states subsequently lowered their general age of majority to 18, impacting the ability of individuals to enter contracts.¹²

In response to the practical challenges of gifting assets to minors without complex trust arrangements, the Uniform Gifts to Minors Act (UGMA) was developed in 1956 and later revised in 1966. This act provided a simpler legal framework for transferring cash and securities to minors.,¹¹ It allowed for the appointment of a custodian to manage the assets until the minor reached the age of majority. Later, the Uniform Transfers to Minors Act (UTMA) was introduced as an extension of the UGMA, broadening the types of assets that could be held in such accounts to include real estate, intellectual property, and other tangible assets. Most states have since adopted UTMA, repealing or superseding their UGMA statutes.¹⁰,⁹

Key Takeaways

• Minors are individuals below the legal age of adulthood, typically 18 or 19 in most U.S. states, and 21 in a few.
• They generally lack the legal capacity to enter into binding financial contracts or directly own significant assets like brokerage accounts.
• Assets for minors are commonly held in custodial accounts under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA).
• Once the minor reaches a specified age (often 18 or 21, depending on state law and account type), they gain full control of the assets.
• Contributions to custodial accounts are irrevocable gifts, meaning they cannot be taken back by the donor.

Interpreting the Minors' Financial Holdings

Understanding how assets are held for minors primarily involves examining the type of custodial account used, most commonly those established under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). These accounts designate a custodian—an adult responsible for managing the assets—until the minor reaches a specific age, at which point the assets irrevocably transfer to the minor. The specific age of transfer (often 18 or 21, but sometimes up to 25 depending on the state and account setup) is determined by state law.,

T⁸h⁷e interpretation of funds held for minors also extends to their potential impact on future considerations, such as financial aid eligibility for college. Assets held in a minor's name, including custodial accounts, are generally considered the student's assets for financial aid purposes and can significantly reduce the amount of aid they qualify for compared to assets held in a parent's name.,

#⁶#⁵ Hypothetical Example

Suppose an individual, Sarah, wants to start saving and investing for her 10-year-old nephew, Ethan. Since Ethan is a minor, he cannot open a direct investment account himself. Sarah decides to open an UTMA custodial account for Ethan at a brokerage firm. She contributes an initial $5,000 and continues to contribute $100 per month. As the custodian, Sarah makes all the investment decisions, choosing a diversified portfolio of exchange-traded funds (ETFs) and mutual funds.

The assets in the account are legally Ethan's, but Sarah manages them for his benefit. When Ethan turns 21 (the age of majority for UTMA accounts in their state), the account automatically transfers into his full control. At that point, Ethan can use the funds as he wishes, whether for college, starting a business, or other purposes, without Sarah's consent or management.

Practical Applications

The concept of minors in finance is most practically applied through specialized investment vehicles designed to hold and manage assets for individuals who lack the legal capacity to do so themselves. These vehicles are predominantly custodial accounts structured under the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). These accounts are widely used for:

• College Savings: Parents, grandparents, and other relatives often use UGMA/UTMA accounts to save for a child's future education expenses. While 529 plans are also popular for college savings, custodial accounts offer more flexibility in how funds can be used once the minor gains control.
• Wealth Transfer: These accounts serve as a straightforward method for adults to transfer wealth to younger generations without the complexities and costs associated with establishing a formal trust. Contributions qualify for the annual gift tax exclusion, allowing substantial amounts to be transferred over time without incurring gift tax liability.
• ⁴ Teaching Financial Literacy: Managing a custodial account provides a valuable opportunity for parents or custodians to teach minors about saving, investing, and general financial literacy. By involving the minor in discussions about asset allocation and growth, they can gain practical experience before assuming full control.
• Inheritance: In cases where a minor inherits assets, UGMA/UTMA accounts can be established to hold and manage these assets until the minor reaches the age of majority.
• Regulatory Oversight: Financial Industry Regulatory Authority (FINRA) reminds member firms of their responsibilities for supervising these accounts to ensure proper management by the custodian and protection of the minor's assets.

##³ Limitations and Criticisms

While beneficial for saving and investing for children, accounts for minors, particularly UGMA and UTMA accounts, come with specific limitations and criticisms. A significant drawback is the irrevocability of contributions; once assets are placed into a custodial account, they legally belong to the minor and cannot be reclaimed by the donor, even if circumstances change. This means the custodian loses control over the funds once the minor reaches the designated age, which could be as early as 18, and the minor can then use the funds for any purpose, regardless of the original intent.

An²other point of contention involves tax implications. While some initial earnings in custodial accounts may be taxed at the child's lower tax rate, higher amounts of unearned income are subject to the "kiddie tax." This tax rule dictates that a portion of a minor's unearned income exceeding a certain threshold is taxed at the parent's marginal tax rate, rather than the child's, significantly reducing the potential tax benefits for higher-earning accounts.,

F¹urthermore, the existence of assets in a minor's name can negatively impact eligibility for college financial aid. Because these assets are considered the student's, they are assessed at a higher percentage than parental assets when calculating expected family contributions for federal student aid. This can lead to a reduction in grant and scholarship opportunities.

Minors vs. Custodial Account

Minors refers to the legal status of an individual who has not yet reached the age of adulthood, typically 18 or 21, depending on state law. This status restricts their ability to independently enter into legally binding contracts or directly hold certain financial assets.

A custodial account, on the other hand, is a specific type of investment account created to hold and manage financial assets for the benefit of a minor. It acts as a legal workaround, allowing an adult (the custodian) to control the assets on behalf of the minor until the minor reaches a designated age, usually the state's age of majority or an age specified by the Uniform Transfers to Minors Act (UTMA). While a minor is the beneficiary and eventual owner of the assets, the custodial account is the legal structure that facilitates this ownership and management during their period of legal incapacity. The minor cannot open the account, but the account is created for the minor.

FAQs

Can a minor open their own investment account?

Generally, no. Minors lack the legal capacity to enter into contracts, which is required to open a brokerage account or similar investment accounts. An adult, such as a parent or guardian, must open a custodial account on their behalf.

What happens to a custodial account when a minor becomes an adult?

When a minor reaches the age of majority in their state (or a specified age for the account, typically 18 or 21), the assets held in the custodial account legally transfer to their full control. The former minor can then manage or use the funds as they see fit. This transfer of control is irrevocable.

Are there tax implications for money in a minor's account?

Yes, there are tax implications, notably the "kiddie tax." While a small amount of a minor's unearned income may be tax-free or taxed at their rate, income exceeding certain thresholds is generally taxed at the parent's marginal income tax rate. Contributions to these accounts may also be subject to gift tax rules for the donor.

Can funds in a minor's account be used for anything?

Once the minor gains control of the assets in a custodial account (typically at the age of majority), they can use the funds for any purpose. Prior to that, the custodian is legally obligated to use the funds "for the benefit of the minor," which is a broad definition and not limited to specific uses like education, unlike some other savings vehicles such as 529 plans.