Custodial Agreement: Definition and Key Terms

What is a Custodial Agreement?

A custodial agreement is a legal contract between the owner of assets or property and a nominee that agrees to hold the assets or property on behalf of the owner.

Companies usually enter into custodial agreements to administer benefits to their employees like 401(k) plans or health savings accounts. Employees benefit from investment professionals acting as their custodians and managing their accounts.

The Custodian in a custodial agreement will handle a variety of tasks for the owner of the assets. Some tasks include:

• Physically holding equities and bonds
• Settling purchases and sales
• Reporting the status of assets
• Tax compliance
• Managing the client’s accounts and transactions

In some cases, a custodial agreement may be executed to control the assets of a minor or an incapacitated adult. Any legal adult can act as the Custodian for a minor or incapacitated person’s assets.

It is common for an adult to gift assets to a minor and manage the account as the Custodian until the minor becomes an adult. This is often done for tax benefits.

Custodial agreements are ideal for absentee owners who are not interested or able to be involved in the daily activities of their accounts and for complex financial transactions that require expert assistance.

For more information on custodial agreements, check out this article.

What is meant by Custodian?

When referring to a custodian in the context of a custodial agreement, a custodian is an institution or individual acting as an agent and exercising legal authority over someone else’s financial assets.

Custodian roles are often held by the following:

• Banks
• Law firms
• Accounting firms

Custodians can also be a company or any legal adult granted permission to handle assets or property on behalf of the owner.

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How Custodial Agreements Work

Custodial agreements can work in various ways depending on the parties, the assets, and the agreement in place.

When the custodial agreement is for a benefits program like a 401(k), first, the Custodian will collect the funds from the employee. This is usually done through payroll deductions. The Custodian then invests the money on behalf of the employee. The Custodian collects a fee; however, this fee is generally lower than any fees the employee would pay as an individual investor.

The employee benefits from this custodial agreement because they receive professional advice, save time, and save money on fees.

Custodians will generally be required to:

• Report distributions made from the accounts to the IRS
• Withholding distribution to cover income taxes
• In the event the owner dies, liquidating the funds and distributing them to beneficiaries

What’s Included in a Custodial Agreement

Custodial agreements will differ depending on the client, assets, and Custodian; however, most custodial agreements will include the following sections:

Background: The background includes information about the client, the Custodian, the assets to be transferred, and the purpose of the custodial agreement.

Definitions: The definitions section defines terms that will be found throughout the agreement. This allows both parties to understand the contract thoroughly and avoids any confusion.

Appointment: In the appointment section, the client officially appoints the selected Custodian, and the Custodian agrees to perform all acts laid out in the contract.

Instructions: The client must provide written instructions to the Custodian for any actions the request. The contract should outline a minimum amount of time that the Custodian needs to receive instructions before the action must take place.

Delivery of Property: The agreement should outline what property will be delivered to the Custodian and how the delivery will take place. The client must also provide proof that they are the rightful owner of the property or assets in question.

Delivery of Documents: The client also must provide, upon request, any documents the Custodian needs to manage the account.

Representations, Warranties, and Covenants: In the custodial agreement, the client must agree that they will comply with all laws, rules, and regulations applicable under the contract.

Records: The client is entitled to copies of any documents the Custodian has pertaining to their assets or property. The agreement should lay out a minimum time the Custodian needs to present the records after receiving the request for documents.

Confidentiality: Custodial agreements are subject to privacy.

Indemnification: The custodial agreement will contain an indemnity clause in which the client agrees to hold harmless the Custodian for any losses, liabilities, or expenses in connection with specific actions as laid out by the agreement.

Duration and Termination: It is important for the agreement to state how long the contract will be valid and how to terminate it.

Signatures: Like any legally binding contract, a custodial agreement needs to be signed by all parties involved.

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Examples of Custodial Agreements

Custodial agreements are more common than you may think. Some examples of custodial agreements include:

• Company retirement plan
• IRA account
• Health savings account
• 401(k) plan

A bank can act as a custodian by handling investments for a customer, like moving money into brokerage accounts, seeking out alternative investment opportunities, monitoring investment activities, and reporting account activity to the owner.

For an example of an actual custodial agreement, click here.

Key Terms in Custodial Agreements

The following is a list of key terms and definitions you may find in a custodial agreement:

Authorized Person. Refers to anyone the client authorizes to give instructions to the Custodian on their behalf.

Book-Entry System. The Federal Reserve Treasury book-entry system for the United States

Interests. Refers to shares, units, or any other interests that the customer has invested or plans to invest

Property. Property is a broad term that refers to all cash, securities, financial instruments, income, distributions, and proceeds that belong to the customer. This term also encompasses any other securities or investment items that the Custodian receives from the client.

SEC. The SEC is the United States Securities and Exchange Commission

Underlying Fund. Refers to any underlying funds or portfolios the customer has invested in or plans to invest.

Custodial Agreements FAQs

What is a custody fee?

A custody fee is the amount of money that a bank or other entity charges for managing an account on an owner’s behalf.

What is a financial record custodian?

A financial record custodian is a bank or other financial institution that agrees to hold a customer’s securities for safekeeping to prevent them from being stolen or lost. Assets may be held in electronic or physical form.

What is a qualified custodian?

The SEC defines a qualified custodian as a bank, broker-dealer, futures commission merchant, or any other entity that legally maintains a client’s funds and securities.

Why do you need a custodian?

A custodian’s responsibility is to hold assets on behalf of the actual owner. Custodians will perform various services like recording transactions, reporting activity to the IRS, and monitoring a client’s accounts.

Do I need to report custodial accounts on taxes?

No, the Custodian of an account does not have to report the account on their own taxes. If a parent is a custodian over a child’s account, that account will be reported under the child’s social security number.

Get Help with a Custodial Agreement

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