What is a Custodian?
A custodian protects your securities (a financial item that has a monetary value) or physical assets from theft or loss.
Custodians are typically large, well-known firms, such as banks. They hold onto your financial assets, whether electronic or physical. A custodian is responsible for the safety of the investments you deposit, such as stocks, bonds, jewelry, and gold. When you make a bank deposit to a custodial account, it goes directly to your custodian with your account number. For some custodial accounts, the Internal Revenue Service requires that the custodian be a bank, savings and loan association, or federally insured credit union, or that it has explicit written approval from the IRS.
Bank of New York Mellon is one of the largest custodian banks in the world. As of September 2019, it had $35.8T in assets under custody. Other major custodial banks include JPMorgan Chase & Co. with $25.7T in custodial assets and State Street with $32.9T as of late 2019.
A custodian is like a safe…
A safe keeps your valuables secure, just like a custodian bank does with your electronic and physical investments. It protects your assets from theft, loss, and unauthorized access. You can get to your assets when you need to, but the custodian acts as an intermediary and keeps them safe in the meantime.
A custodian’s primary purpose is to house and protect your assets — kind of like a secure warehouse. These assets may include physical valuables (like gold), important papers (like loan documents or pension fund records), and electronic assets (like securities). The custodian should maintain careful records and send you a monthly or quarterly statement about your account.
Custodian banks can also process transactions. For example, the custodian can hold securities in the institution’s name, but on behalf of the real owners. In other words, it acts as a fiduciary (someone legally responsible for acting in the interest of his or her client). The custodian can then perform actions in the client’s name, such as buying and selling stock.
If one of your stocks is entitled to a dividend (a quarterly payment from a company’s profit), your custodian can help you receive your dividend and report it to the Internal Revenue Service if you need to. Similarly, if one of your bonds is eligible for an interest payment (also known as a coupon), your custodian will help gather all relevant tax-related documents. It’s important to note that custodian banks don’t offer tax advice — They just hand you the necessary tax documents.
Custodians can also keep track of company-specific activities, such as stock splits (where a company cuts the stock price while increasing the number of shares available). Some custodians even report corporate actions, such as corporate restructuring, that may impact the value of the company’s securities.
While a custodian bank manages investment funds within the United States, a sub-custodian bank (also called an agent bank) specializes in transactions abroad. For example, let’s say you have a global custodian account with the Bank of New York Mellon. As of November 2019, if you trade on the international stock market, and hold assets in Brazil, your shares would be held by the Bank of New York Mellon’s sub-custodian bank, Citibank N.A. The latter would be responsible for managing your assets in Brazil and foreign exchange.
There are two primary types of custodial accounts: individual retirement accounts (IRAs) and custodial accounts for children.
An individual retirement account is an investment account designed to help people save for retirement. Its tax benefits vary depending on the type of IRA you have and how much you contribute.
There are four main types of IRAs: 1. Traditional IRA: This retirement account allows for tax-deductible contributions using your pre-tax income. When you withdraw from it, you’ll likely pay taxes on the funds you take out. 2. Roth IRA: A Roth IRA lets you grow the account tax-free. You contribute to a Roth IRA with your post-tax income and generally won’t pay any additional tax if you follow the regulations. 3. SEP-IRA: This stands for “simplified employee pension individual retirement account.” Self-employed people, small-business owners, and independent contractors, primarily use this type of IRA. Contributions are from pre-tax income. 4. SIMPLE-IRA: This stands for “savings incentive match plan for employees individual retirement account.” Small businesses with a maximum of 100 employees can use this type of IRA. Contributions come from your pre-tax income.
The Internal Revenue Service requires that all IRAs be a trust or custodial account. The custodian must be a bank, a savings and loan association, a federally insured credit union, or another IRS-approved institution.
Custodian accounts protect the money you want your child to have in the future. No one but the beneficiary can withdraw from the custodial account. That also means that creditors and other family members can’t touch the funds, and neither can the person who deposited them. A custodian keeps the assets secure until the minor reaches the age of majority.
You can set up a few different custodial accounts for minors. Here are the three main options:
Uniform Gift to Minors Act Developed in 1956 and revised a decade later, the Uniform Gift to Minors Act (UGMA) allows parents or other relatives to transfer assets — such as cash, stocks, bonds, and insurance policies — to a minor without creating a special trust. The framework was created at a federal level and adopted by individual states. The age when the beneficiary can take control of the assets varies by state, though most set the age at 18.
Uniform Transfers to Minors Act In 1986, the Uniform Transfers to Minors Act (UTMA) expanded on the Uniform Gift to Minors Act (UGMA) and made a few changes. First, most states raised the age when beneficiaries can take control to somewhere between 18 and 25. The new law also expanded the definition of assets from monetary items, like cash and securities, to include property such as real estate, patents, and fine art. All states, except South Carolina, have adopted UTMA.
It’s important to note that you must pay taxes on your UGMA and UTMA custodial account contributions. They also aren’t tax-deductible. Although there is no contribution limit, you may want to keep the amount under $15,000 a year for a single tax-payer ($30,000 per year for a married couple filing jointly) to avoid the federal gift tax. The account is considered the minor’s asset, which may affect financial aid eligibility when he or she applies for college.
Coverdell Education Savings Account The Coverdell Education Savings Account (ESA) is slightly more restrictive than other custodial accounts for children. It has an annual contribution limit of $2,000. Although contributions are not tax-deductible, earnings can grow tax-free. The beneficiary can use the funds to pay for what the Internal Revenue Service considers qualified education expenses.
Bank custodians charge fees for their services, which depend on what the customer needs. Some custodian banks charge fees based on the total value of assets under custody.
For example, according to the 2008 State Street Bank Fee Schedule, it charges 0.50 basis points (0.005%) for the first $10 billion under custody in U.S. accounts. They also have itemized charges, such as a $4,500 base price charge per fund and $8.25 for each unique security in the U.S. equities market.
Depositary services are popular in the European Union. Under the Alternative Investment Fund Managers Directive (AIFMD), each Alternative Investment Fund (AIF) must appoint a depositary.
Depositary services are similar to custodian banks – They safeguard a client’s portfolio assets. They also monitor cash flow and reconcile account balances.
On the other hand, many custodian banks have international services. They may offer other financial services that a depositary service does not, such as account opening services in investment markets and tax services.
Investment banks do more than simply house your investments. These financial institutions employ advisors who try to grow the assets in their custody. They also take part in complex business transactions and investment management, such as facilitating mergers and issuing new shares of a stock in an initial public offering (IPO). As a result, investment banks carry higher risks for investors than custodian banks or depositary services.
Custodians are typically large, reputable firms. The Internal Revenue Service has strict rules about what type of custodian can manage your individual retirement account. For example, the custodian must be a bank, savings and loan association, or federally insured credit union. Non-bank custodians – such as your financial advisory firm – must file a written application with the IRS.
The Securities and Exchange Commission, which regulates securities markets, has identified four types of financial institutions as qualified custodians to maintain your funds and securities: banks, savings associations, registered broker-dealers, and registered future-commission merchants. These conform to the SEC’s “custody rule,” which is designed to protect investors against theft and abuse by investment advisors.
Under the Advisers Act, the SEC’s “custody rule” regulates the custody practices of financial advisors. For example, the rule requires an independent public accountant to do a surprise examination of the client’s funds and securities every year.
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