Hey there, proud parent! If you're dreaming of a future where your little bundle of joy is not only a smarty-pants but also financially savvy, you're in the right spot. Let's talk investing for kids and how to get them started on investing in their financial future (pun intended!).
Can a Minor Have a Brokerage Account?
Before we dive deep, let's address the elephant in the room. Minors cannot directly open a brokerage account because they're, well, they're under 18 and legally unable to enter into a contract. But that's ok — your child can have a brokerage account with the help of an adult, such as a parent or a guardian. With the right account, you can buy stock for a minor.
What Types of Investment Accounts Can I Open For a Child?
While your budding investor cannot directly open a brokerage account, you have a few options to get them started.
Let's dive into some of the choices:
Joint Brokerage Accounts
Often termed joint tenants with rights of survivorship (JTWROS) accounts, these are co-owned by a parent and the minor. Consider it an equal partnership; your child gets as much access and rights to make changes as you do. Perhaps that's why these types of accounts are less common, the younger the child is. If your child is now an adult, this may be a more viable option.
Custodial Accounts
Custodial accounts allow parents to manage investments for children until they reach the age of majority (typically 18 or 21, depending on the state). Think of it like financial training wheels. Once children are of legal age, the assets are theirs to control fully. It's a great way to build a nest egg that they can use for education, their first home, or other investments.
Custodial accounts are ideal for younger children not yet ready to manage their investments. There are two types of custodial accounts: Uniform Gifts to Minors Act (UGMA) accounts and Uniform Transfer to Minors Act (UTMA accounts). The main difference is that UGMA accounts can only hold cash and securities, while UTMA accounts can also hold other assets, such as real estate or art.
- UGMA Accounts (Uniform Gifts to Minors Act): UGMA accounts can hold only two types of assets: cash and securities (such as stocks, bonds, and mutual funds). These accounts have restrictions on the types of assets they can hold, limiting them to financial instruments. The assets in a UGMA account are managed for the benefit of the minor until they reach the age of majority, which is typically 18 or 21, depending on the state.
- UTMA Accounts (Uniform Transfer to Minors Act): UTMA accounts, on the other hand, have broader flexibility in terms of the types of assets they can hold. In addition to cash and securities, UTMA accounts can also hold other types of property, such as real estate, art, patents, and royalties. This broader scope of assets makes UTMA accounts more versatile for families with non-financial assets they wish to transfer to their child. The age at which the minor gains control over the assets in a UTMA account is usually the same as with UGMA accounts, typically 18 or 21, depending on state law.
The main difference is that UGMA accounts can only hold cash and securities, while UTMA accounts can also hold other assets, such as real estate or art.
Does a custodial account affect financial aid eligibility?
Yes, a custodial account can affect financial aid eligibility. When filling out the FAFSA, 20% of a student's assets are considered available for college expenses, while only 5.64% of a parent's assets are considered. As a result, a large custodial account in your child's name could reduce the expected family contribution (EFC), which in turn could affect their aid award.
Opening a Roth IRA Account for a Working Child
A Roth IRA can be a fabulous choice if your child has earned income (think babysitting, lawn mowing services, lemonade stands, or other part-time jobs). A Roth IRA is an individual retirement account that grows tax-free and sets the stage for retirement (yes, we're thinking THAT far ahead!).
529 plans — the most tax benefits for education
Specifically designed with education in mind, 529 plans offer tax advantages, making them a favorite for parents aiming to fund their a child's higher education. Your child can use the funds for tuition, books, and other educational-related expenses.
Coverdell ESA — another option for education savings
Think of Coverdells as 529's lesser-known sibling. Another education-focus account, Coverdell ESAs allow parents to save up to $2,000 annually for a child's education expenses, from elementary through college. While the contribution limit is lower than 529 plans, they offer more flexibility and investment options.
Help your kid decide what to invest in
Once you have opened an investment account for your child, you will need to decide what to invest in. It's a fantastic learning opportunity! Depending on the type of account and the provider you choose, you may have access to stocks, bonds, ETFs, mutual funds, CDs, and other investment options. Who knows? You might have a young Wall Street prodigy in the making.
How To Open an Investment Account for Minors
Depending on the type of account and the provider you choose, the account opening process may vary slightly, but here are some general steps that you can follow:
- Choose an account type
- Choose a provider – a financial institution or firm that offers the type of account you want for your child.
- Fill out an application
- Fund the account once opened
What do I need to open a brokerage account?
Typically, you'd need proof of identity for both parent and child, the parent and child's Social Security number, a linked bank account, and other personal information.
Best Brokerage Account for Teens
Transitioning from childhood to adolescence often involves increased financial awareness and the desire to explore investing. For teens looking to start their journey in the world of investing, several joint brokerage accounts cater to their specific needs and preferences. Here are three popular options:
- Fidelity Youth Account: Known for its research resources and low costs.
- Charles Schwab: Offers a wide range of investment products and services. Schwab acquired TD Ameritrade, which was a fan favorite.
Best Custodial Brokerage Account for Kids
Best Roth IRA brokerage account for kids:
- Vanguard: Low account fees and a massive array of investment options.
- Charles Schwab: Robust investment options and no account minimum.
- Fidelity: Access to zero fee funds and no account minimum.
Best 529 plans for kids:
- Vanguard's 529 College Savings Plan: Solid investment choices and low account fees.
- Fidelity's UNIQUE College Investing Plan: Diverse and flexible.
Best Coverdell ESA for kids:
- ETRADE Coverdell ESA: Offering a wide variety of investment options with no account minimum.
Gift taxes
Got a little extra cash to spare and thinking of investing it in your kid's account? Be careful, my friend! The IRS has gift tax rules that you need to follow. The good news is that you can gift up to $18,000 per person in 2024 without getting taxed. The $16,000 won't count towards a $12 million lifetime exemption you have on gifts. The right thing to do is to file a gift tax return to report any gifts and then pay tax on amounts over your lifetime exemption.
The gift tax rate can range from 18% to 40% – yikes! But hey, don't let that discourage you from being generous.
You can still give unlimited amounts for qualified education or medical expenses without any tax consequences as long as you pay the institution or provider directly. And, of course, you can always give unlimited love and support to your kiddo without any taxes involved.
Who pays taxes on a custodial account or joint brokerage account?
A custodial account's earnings are taxed to the child, but be wary of the “Kiddie Tax.” In a joint account, taxes depend on contributions. If you contribute more, expect Uncle Sam to knock on your door.
What is the Kiddie Tax?
Let's talk about the kiddie tax, which is like a special bouncer at the club of Taxation for kids under 18 (or under 24 if they're full-time students and not fully supporting themselves). Basically, if a child earns more than $2,200 in unearned income (like interest, dividends, and capital gains), they might have to pay taxes at their parent's higher rate.
Under the framework of the kiddie tax, the initial $1,150 of unearned income enjoys protection through the standard deduction, rendering it exempt from taxation. Subsequently, the next $1,150 is taxed at the child's applicable marginal tax rate. Any surplus beyond this, surpassing the $2,300 threshold, is then subjected to taxation at the parents' corresponding marginal tax rate.
It's like the kiddie tax is saying, “Sorry kiddo, you can't sneak into the VIP section of lower tax brackets just because your parents are cool.” But watch out because even income from investments, gifts, or inheritances can get nabbed by the kiddie tax. So, don't let this sneaky tax rule catch you off guard!
Other Ways to Invest for Kids
When it comes to investing for your kids, feel free to break free from the financial clichés and dive into some off the beaten path investment ideas that can set your child on a path to financial awesomeness. You don't have to stick to only brokerage accounts.
Tiny Tycoons in the Real Estate Realm
Who says real estate is just for the big players? Get your little ones in on the action with publicly traded real estate investment trusts (REITs). It's like a mini adventure in property ownership, minus the mortgage headaches. You can also look at private real estate investments together.
Kiddie Capitalists and Startup Shenanigans
Is your kid the next tech titan in the making? Invest in their startup fantasies (and maybe a lemonade stand too) through platforms that connect pint-sized investors with up-and-coming ventures. After all, every Elon Musk started somewhere – why not the lemonade stand of the future?
From dollars to daring dreams, investing for kids doesn't have to be a snooze-fest. So, toss out the financial rulebook and scribble your own chapter. Because when it comes to making their piggy banks grow, a dash of imagination might just be the secret ingredient for financial fairy tales!