What Is a Custodial Agreement?
A custodial agreement is an arrangement wherein one holds an asset or property on behalf of the actual owner (beneficial owner). Such agreements are generally entered into by state agencies or companies to administer various benefit programs.
- With a custodial agreement, a nominee or registered owner holds assets or property on behalf of the real owner.
- Examples include employee benefit programs such as 401(k) plans or health savings accounts in which a company hires a third party to administer the plan.
- These kinds of arrangements give employees the benefit of having an account managed by an investment professional
How a Custodial Agreement Works
An example of a custodial agreement would be a company retirement plan. Many, if not most, companies hire a third party to administer such plans in order to collect payments from the employer and employees, invest the funds, and disburse the benefits.
The advantage of this arrangement is that the beneficial owner gets professional advice, which saves time and often pays lower fees than would otherwise be available had the money been handled by each individual owner.
With custodial agreements used for benefits programs, the custodian collects employee funds through regular payroll deductions and invests the money; any fees connected to these agreements are typically lower than the ones that would be charged to individual investors.
Ways Custodial Agreements Are Applied
Custodial agreements are used for a variety of benefit programs such as IRAs and health savings accounts. Typically, the agreement outlines the payment from the individual will be disbursed to the custodian who will, in turn, see to it that the funds are held at a bank or other financial institution. Depending on the type of account, the custodian might not be liable if the worker’s employer does not furnish the matching funds that were intended for the benefit. For instance, if a company does not provide the matching contribution to a retirement savings plan, any losses that may be incurred would not be the responsibility of the custodian.
Under such agreement, a custodian may be required to report to the Internal Revenue Service any distributions made from the accounts or assets they are overseeing. However, it is not necessarily the custodian’s duty to report why the distribution was made. For example, if an employee with a health savings account receives a distribution, the employee may hold the responsibility for substantiating that this went towards what is deemed a qualified medical expense.
The employee, not the custodian, may need to maintain any records that corroborate the distribution was made on a tax-free basis. It could also be up to the employee, and not the custodian, to determine what income taxes are due on the distribution, as well as if there are any tax penalties that would apply. The custodian also might not be responsible for withholding part of the distribution that would be used to cover any income taxes that are due.
If the account owner were to die, the custodian could be responsible for liquidating the funds in the account and then see to the distribution of the assets to the beneficiaries in accordance with parameters of the decedent’s estate.