Course: Fundamentals of Financial Planning
Lesson 6: Educational Savings Techniques

Student Question:


I am referencing the “Key Information – Coordination with Tax Credits” section.

When it says “custodial accounts do not provide income tax deferral,” is this to say that a donor will earn and pay income tax on money received that is then gifted to the beneficiary?
Assuming the gift is less than $15,000 annually, there is no additional tax? Once this money is withdrawn for education expense, credits can be claimed as the gift was already taxed as income when earned?

It would be great if you could clarify this section.



Instructor Response:

Hi Carlee,
Thank you for the custodial account question
First, let’s establish the players:

  • The donor contributes the gift,
  • The custodian manages the custodial account until the child reaches the age of majority, and
  • The child is the beneficiary of the custodial account. 

We need to keep federal income tax and federal gift tax separate when considering the taxation of gifts to custodial accounts.

Income Tax

  • The IRS considers the child the legal owner of the custodial account.  
  • Portfolio income and capital gain generated in the custodial account are included in the owner’s (child’s) federal total gross income.
  • Once a donor contributes property to a custodial account, the donor is no longer responsible for income taxes on income or capital gains from the contributed property.
  • You are correct.  In many cases, the donor must have paid income taxes on the contributed amount before the gift was made.  For example, if Mom contributes $15,000 to her son’s custodial account from her W2 compensation, she will generally have paid income tax on the compensation. From that perspective, she contributes “after-income-tax dollars” to her son’s custodial account.   

Gift Tax

  • A donor may contribute gifts to a custodial account for the benefit of a child (the beneficiary).
  • Gifts of cash or other unrestricted property of up to $15,000 per year per donor are not generally considered taxable gifts for gift tax purposes.
  • Only taxable gifts from a donor in excess of an indexed cumulative limit ($11,580,000 in 2020) are generally subject to gift taxes. 
  • The donor is primarily responsible for payment of any gift tax due.

How completely does this address your question?  

Onward and Upward,