The Kiddie Tax, and What a Custodial Account Really Does
Putting savings in a child's or grandchild's name looks like a way to have investment income taxed at a child's rate. It is not. Above a modest threshold, unearned income is taxed at the parent's rate — and when the child reaches the age of majority the money becomes theirs to spend on anything at all.
- The threshold is small:: A limited amount of unearned income is taxed at the child's own rate or not at all. Above that, the parent's rate applies.
- It reaches students to 24:: Full-time students under 24 are covered unless their earned income exceeds half of their support.
- The money is the child's:: A custodial account is an irrevocable gift. At the age of majority they can spend it on whatever they like.
- It counts against aid:: Assets held in a student's name weigh more heavily in financial aid formulas than assets held by a parent.
Where the AI summary above gets this wrong
"Open a custodial account for your child so the investment income is taxed at their lower rate."
That's surface-true. Here's what it misses:
- The parent's rate applies above a low threshold — The kiddie tax exists precisely to stop income shifting. Beyond a modest annual amount, a child's unearned income is taxed as though it were the parent's. On a portfolio of any size the intended benefit is not just reduced but eliminated.
- The gift cannot be taken back — A custodial account transfers ownership immediately and irrevocably. When the child reaches the age of majority in their state, they take control, and there is no mechanism to restrict what the money is used for. Parents frequently discover this at the point it becomes relevant.
- A 529 does the intended job better — For education saving, a 529 grows tax-free rather than at the parent's rate, stays under the account owner's control, and is weighted more favourably in financial aid calculations. Almost every reason people give for opening a custodial account is better served by a 529 or by simply holding the money in their own name.
01 How the rule works
A limited amount of a child's unearned income each year is taxed lightly — some at no tax and some at the child's own rate. Everything above that is taxed at the parent's marginal rate, computed on Form 8615 and reported either on the child's return or, in some cases, on the parent's.
Unearned income means interest, dividends, capital gains, and distributions from certain accounts. Wages from a job are earned income and are taxed at the child's own rate however large they are.
The reach extends further than most people expect. It covers children under 18, 18-year-olds whose earned income does not exceed half their support, and full-time students under 24 on the same test. A university student with an investment account is squarely inside it.
Shows: the additional tax when a child's unearned income above the threshold is taxed at the parent's marginal rate instead of the child's, using the rate gap you enter. Ignores: the two-tier structure below the threshold, whether the income is qualified dividends or long-term gains taxed on the preferential schedule, state tax, and the child's own earned income.
Source: Topic 553: the kiddie tax
02 What a custodial account actually is
A custodial account under a state uniform transfers act is an irrevocable gift to the child, managed by a custodian until the age of majority set by that state. The assets are legally the child's from the moment they go in.
Two consequences follow. The income is the child's, so the kiddie tax applies to it. And at majority the child takes full control, with no restriction on use — university fees, a car, or anything else.
For financial aid, assets in a student's name are assessed more heavily than the same assets held by a parent. A large custodial balance can therefore reduce aid eligibility at exactly the moment it was meant to help, which sits alongside the wider cost of children arithmetic.
Source: About Form 8615
03 What to do instead
For education, a 529 is the better vehicle in almost every respect: tax-free growth rather than taxation at the parent's rate, the account owner keeps control, the beneficiary can be changed, and the aid treatment is more favourable.
For a general gift with no strings, the custodial account does what it says — but it should be opened knowing that the money will be handed over unconditionally at 18 or 21, and sized accordingly.
Where a custodial account already exists and has grown, the levers are limited. Holding investments that produce little annual income reduces the kiddie tax exposure, since unrealised gains are not taxed until sold. Spending the account on the child's expenses before majority is permitted where those expenses are for the child's benefit, and is worth considering rather than letting the balance build.
The custodial account is usually opened by a grandparent with entirely good intentions and no idea that the money becomes an eighteen-year-old's to spend as they choose. That is not always wrong — some families mean exactly that — but it should be a decision rather than a surprise. If the purpose is education, use a 529. If the purpose is a gift with no strings, the custodial account is honest about what it is, and the size should reflect what you would be comfortable handing over on a birthday.
FAQ
At what age does the kiddie tax stop applying?
It covers children under 18, 18-year-olds whose earned income does not exceed half their support, and full-time students under 24 on the same test. Beyond that, the child's own rate applies.
Can I get money back out of a custodial account?
No. It is an irrevocable gift to the child. It can be spent for the child's benefit before majority, but it cannot be returned to the person who gave it.
Is a 529 better than a custodial account?
For education saving, generally yes. A 529 grows tax-free rather than being taxed at the parent's rate, the owner keeps control, and it is treated more favourably in financial aid formulas.
Sources
Regulator references
- Topic 553: the kiddie tax · Internal Revenue Service · 2026Which children are covered and how their unearned income is taxed.Last verified: 2026-09-07
- About Form 8615 · Internal Revenue Service · 2026The form on which a child's unearned income is taxed at the parent's rate.Last verified: 2026-09-07
- Topic 409: capital gains and losses · Internal Revenue Service · 2026The gains that a custodial account realises and how they are characterised.Last verified: 2026-09-07
Calculator unit tests · the assertions this page's worked example is checked against, and their last result
Changelog
- 2026-09-07 — initial publish (new format)
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Jordan Reeves
Founder of Talk Through Wealth. A software engineer for over a decade before turning to retirement planning, Jordan built the projection engine after watching family members get fragmented, country-by-country advice that never reconciled. He writes about retirement the way the engine computes it: month-by-month, lifetime-long, and skeptical of any rule of thumb that hasn't been run through the math.