A custodial account is an account set up at a bank, brokerage firm or other financial institution in the name of a minor, with a parent or other adult named as the custodian until the child turns 18 to 21, depending on the state. These are also called UGMA or UTMA accounts, which stands for Uniform Gift (or Transfer) To Minors Act.

The investment options are almost unlimited, but tax benefits can be slim.

The first $850 in annual account earnings is tax-free. The next $850 in earnings is taxed at the child's rate. Annual earnings over $1,700 are taxed at the parents' rate until the child turns 18. There are no contribution limits, but this so-called kiddie tax eliminates the tax benefits on large custodial accounts.

Custodial accounts can hurt your chance of getting financial aid because in determining how much a family can pay, aid formulas generally assess a larger percentage of student assets than parental assets. UGMA and UTMA accounts are considered student assets.

Another downside: Once you put money in a custodial account for a child you can't take it back, even he decides to spend it on a motorcycle instead of tuition.