Custodial Roth IRA vs. UGMA Account: Which Is Right For You?

Investing for your kids can give them a helpful resource to use in the future. In terms of where to actually stash the funds you want to contribute toward their future, you can choose from several different account types, each of which comes with its own advantages and disadvantages.

A custodial Roth IRA can help you plan for your child’s retirement before they even leave home. There are worthwhile tax advantages, but there are limits around who’s eligible for an account and how your child can use the money. A custodial account for investing (such as a UGMA/UTMA—which in this article we’ll refer to as an “investment account for kids”) can maximize flexibility and be a convenient option for many families, but it has fewer tax advantages, and withdrawals must be for the benefit of the child.

Get the details to help you plan which account type (or combination) could be right for your kids.

What Is a Custodial Roth IRA?

A Roth IRA is a retirement account you fund with after-tax dollars. If you fund the account for at least five years and don’t take distributions until you reach age 59½, then your qualified withdrawals are tax-free—including gains on the investments. You can also withdraw contributions (without earnings) at any time without paying taxes or penalties.

A custodial Roth IRA is a tax-advantaged retirement savings account that you can open on your child’s behalf if they have earned income. The primary purpose of a Roth IRA is long-term retirement savings, but it also offers some flexibility for other qualified expenses.

Custodial Roth IRA rules

There are no age limits to open a custodial Roth IRA for your child. The essential requirement to qualify is that your child has to earn income. A baby getting paid to star in a commercial counts, and so would money kids earn by babysitting or doing yard work (you might need to keep records of your child’s income—consult with a financial professional). Gift money or allowance, however, wouldn’t count. So, if the child doesn’t have earned income, you’ll need to explore other ways to invest for the future.

The maximum contribution for a Roth IRA in 2025 is $7,000 or the total amount of taxable compensation for the year, whichever is less.

By opening a Roth IRA for a child, you’re taking advantage of the many decades to go before the child reaches retirement age, meaning plenty of opportunity for contributions to grow and accumulate much more value. While there may be penalties for taking money out early, there are a few exceptions where a child can use money from a Roth IRA before they reach age 59½ without penalty, such as:

• Qualified higher education expenses (e.g., tuition, textbooks)

• Up to $10,000 to buy (or build) a first home

• Up to $5,000 for a qualified birth or adoption of a child

Custodial Roth IRA benefits

A custodial investment account can offer several advantages to help you plan for your child’s future:

• Control of the account: Parents or guardians manage the account on the child’s behalf, including making contributions and choosing investments, until the child reaches the age to take control of the account (typically at age 18 or 21, depending on your state law; some states may allow you to delay account transfer until the child reaches age 25).

• Tax-free growth: Contributions grow tax free, and qualified withdrawals are free from federal taxes or penalties.

• Penalty-free withdrawals: A custodial Roth IRA permits the child to withdraw money before age 59 ½ without penalty for certain qualified expenses, like higher education expenses or a first home. This can be a helpful way to give kids a financial boost while they’re starting out in adulthood, rather than only helping prepare for their eventual retirement.

Custodial Roth IRA drawbacks

While there are meaningful advantages to a custodial Roth IRA, there are some potential drawbacks to consider as well:

• Earned income requirement: Some children simply aren’t eligible for a custodial Roth account because they don’t earn their own money. You don’t want to push children to work before they’re ready just to take advantage of another financial account option.

• Contribution limits: In 2025, you can contribute up to $7,000 or the total amount of your child’s taxable earned income, whichever is less. If you and any other contributors (e.g., grandparents) might exceed that limit, you’ll need another option for the excess contributions.

• Limited flexibility: There are certain exceptions when a child can withdraw money before age 59 ½ without penalty, but these may come with their own withdrawal caps or fail to cover all situations when your child needs some extra funds. Non-qualified withdrawals come with taxes and penalties.

How to open a custodial Roth IRA

If a custodial Roth IRA sounds like a good addition to your plans for your child, the first step is choosing a financial institution to work with. Different banks or brokerage firms may offer options with varying fees or investment structures for long-term growth, so do your research to find an account that feels right for you. You might want to speak with your financial professional if you have questions about documenting your child’s income or planning your financial strategy for their future.

You’ll need your child’s personal information on hand, including their Social Security number and documents to prove their earned income. Work with your chosen provider to open the account and ensure it’s set up to follow any applicable rules from the IRS. You’ll have control over investments in the account, so you can select a mix of investments such stocks, bonds or mutual funds based on account options, your own risk tolerance and the amount of time before you expect your child to use the money.

How UGMA/UTMA Accounts Work

A UGMA/UTMA account follows guidelines laid out in the Uniform Gifts to Minors Act or Uniform Transfers to Minors Act (details can vary by state). You contribute money and invest on your child’s behalf until they come of age to take control of the account (typically age 18 or 21, and in some states you can choose an alternative age). Any contribution to the account becomes your child’s property, and they can use the funds for just about any purpose.

UGMA account rules

For tax year 2024, first $1,300 in gains in a UGMA or UTMA account are exempt from federal taxes. The next $1,300 are taxed at the child’s tax rate, which typically means a lower tax bill than your own tax rate. Any gains over this amount are taxed at the parent’s rate.

Contributions to the account are irrevocable. As soon as the money enters the account, it becomes the child’s legal property, and the adult managing the account has a responsibility to act in the child’s interest.

Once the child reaches the age of majority, they take full control over the account. From there, they can continue to let investments grow, or withdraw money and use it toward any purpose.

UGMA account benefits

A UGMA account offers some benefits that can make it a smart fit for many families:

• No earned income requirement: Your child doesn’t need to earn their own income to be eligible for an account. You can open an account for your child whenever you’re ready.

• No contribution limits: You (or anyone else, such as a grandparent) can contribute as much as you like without hitting a contribution cap. The gift tax exclusion is $19,000 in 2025, so you can contribute generously before you’d even need to submit a gift tax form to the IRS.

• Flexibility to use money freely: While there’s less tax advantage in investing through a UGMA/UTMA account than a Roth IRA, there’s far more flexibility in how your child can use the funds. Once your child becomes an adult and takes over the account, they have full power to use the money for any purpose, without caps or penalties. A home down payment, travel, school expenses, a car, seed money for a business—their imagination is the limit.

UGMA account drawbacks

It’s always wise to consider both the advantages and disadvantages of any account option. Some drawbacks to know about include:

• Tax implications: You can enjoy some tax advantages on earnings in a UGMA account thanks to the Kiddie Tax laws, but you may need to pay taxes on some earnings, either at your child’s or the parent’s tax rate. This may reduce overall growth in comparison to investing the same amount in a custodial Roth IRA that offers tax-free growth for all earnings.

• Financial aid considerations: While retirement accounts (including IRAs) don’t count as assets in calculating financial aid eligibility on the FAFSA, UGMA/UTMA accounts do count as student assets. A custodial investing account can have a larger impact on financial aid than a retirement account like an IRA.

How to open a UGMA account

Similar to a custodial Roth IRA, start by choosing a bank or brokerage with terms and options that sound right for you. (FYI: Fabric by Gerber Life offers a UGMA, too.) Gather the required personal information about your child and fund the account by contributing cash or transferring assets. You’ll be responsible for managing the account until your child is old enough to take over, including staying on top of filing any applicable taxes.

Custodial Roth IRA vs. UGMA Account: Which Is Right For You?

Investments for your child can become a valuable resource they can draw on when they reach adulthood. There are advantages and disadvantages to any option. You might split contributions between multiple types of accounts, or you might prefer to focus on the account that aligns better with your plans and goals.

Tax-advantaged growth: Custodial Roth

A Roth IRA offers more potential for tax-free growth and distributions. If your priority is tax-advantaged growth over a long timespan (and your child is willing to be patient), this might be a good account type to consider. A UGMA/UTMA account offers some tax advantages, but you will still need to pay taxes on gains over the exemption limit.

Penalty-free flexibility: UGMA account

Your little one may want to be an astronaut-singer-marine biologist now, but their plans may change in lots of unexpected ways by the time they grow up. Your goal may be to give them as much flexibility as possible to use money to fit their needs.

A Roth IRA does offer certain helpful exceptions to use money without penalties before age 59½. But if you want more flexibility, a UGMA/UTMA custodial account doesn’t set any restrictions over how your child can or can’t use the money, once they hit the age of majority (typically 18-21, depending on the state).

Investing as early as possible: UGMA account (usually)

Technically, there is no age limit on when you can open a Roth IRA. Realistically, however, most babies and toddlers aren’t earning income, and therefore aren’t eligible for Roth IRA contributions. Investing when your kids are as young as possible can offer the longest time horizon to take advantage of potential earnings. A kids investment account can help you get a head start before your kids earn money.

Maximizing financial aid: Custodial Roth IRA

The FAFSA recently released new, simplified rules, but it’s hard to predict what other financial aid rules may change by the time today’s kindergartners are ready to apply to college. For now, money in a child’s investment account can factor into financial aid calculations. By contrast, retirement accounts don’t currently count on a FAFSA, so a Roth IRA won’t reduce financial aid eligibility.

You might want to consider the advantages and disadvantages of how various accounts line up with your plans.

No caps on contributions: UGMA account

Taking small actions and giving investments time to grow is a great habit. Any amount you put toward your child’s future counts.

Some families may wish to make larger contributions. Or other relatives may want to pitch in, so contribution limits can be a potential consideration. If you open a Roth IRA for your child, the max total between all contributors is the lesser amount of your child’s earnings or $7,000 (in 2025). If your child earns $2,600 at a summer job and has no other income, that’s the maximum you can match in a Roth IRA for the year. Depending on your goals, you may want to consider choosing (or adding) a kids investment account to the mix so you can make higher contributions.

Taking action now can build toward a gift your child can benefit from in the future. Learning about options can help you feel confident about your choice, and you can choose accounts that fit your plans. A Roth IRA, investment account for kids, or both could be part of your financial preparations for your child.

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