While our kids will never become day traders in elementary school, investing isn’t only for adults. Children can learn valuable lessons about money, managing risk, growing wealth and investing in themselves and their future. A custodial brokerage account could be a good start on their road to financial literacy.
It’s never too early or too late to teach your kids about financial literacy. Parents can include their children in specific money management decisions by helping their kids set up an investment account, teaching them how to establish an investment strategy and showing them how to grow their earnings.
Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minor Act (UTMA) accounts are custodial accounts designed to hold and protect assets for your kids. For children who don’t have taxable income, you can use this account to save and invest money for them until they become adults. The funds are irrevocable gifts and belong to your kid.
What’s the difference between a UGMA and a UTMA account?
Uniform Gift to Minors Act (UGMA) accounts are available in all 50 states and limited to financial products, including cash, stocks, bonds and insurance policies. On the other hand, Uniform Transfer to Minor Act (UTMA) accounts can include other assets, such as real property and real estate. Vermont and South Carolina don’t allow UTMA accounts.
Your state determines at what age — usually between 18 and 25 — your child obtains legal control of the account and can use the money for whatever purpose.
Here’s how to open a custodial brokerage account for a minor child:
Select an investment firm. Compare banks, credit unions and brokers to find a company that offers these accounts and fits your needs, including initial deposit minimums, account requirements and administrative fees.
Open an account. You’ll need to fill out an application with all required personal information for both the custodian — the adult who manages the account — and the beneficiary — your minor child.
Fund the account. Transfer money into the brokerage account.
Choose your investments. Select the financial assets you’d like to invest in, such as stocks and bonds.
Once your child has started earning money for themselves, including part-time babysitting gigs, it could be time to teach them how to put away a portion of their income towards retirement. Keep in mind that you can’t include nontaxable funds, such as gifts or birthday money, and your kid won’t be able to access the earnings without a penalty until age 59 1/2.
Here are the steps to open a custodial individual retirement account (IRA) for your child:
Compare investment companies. Select an investment firm for your custodial IRA by weighing the fees, account minimums and whether it offers a traditional IRA or Roth IRA.
Open an account. Submit a custodial IRA application with all the required information, including your Social Security number and employment details.
Fund the account. Input your banking info to transfer funds into the custodial IRA.
Select your investments. Choose the type of investment you’d like to allocate.
(Better still, if your kid is a teen, let them do the paperwork. They can read our piece on investing for teens.)
An extra perk of investment accounts is the ability to build additional wealth thanks to the power of compound interest. In other words, your money earns interest, and that interest also earns interest. Your money can grow automatically and take on a life of its own — even if you don’t add to the account.
To help put this into perspective, imagine you contributed $50 a month into a custodial Roth IRA. In 30 years, you would have contributed $18,000 into the custodial IRA, but your child could have over $50,000 of tax-free money (based on 6% annual growth with interest compounded month.
Kid-friendly investment vehicles
While you as the custodian have the final say on the investment options in the custodial account, your kids can help have some input on what they would like to invest in, including companies they recognize or that align with their interests. Names like Disney or Mattel can help kids understand how stocks relate to their real worlds.
Stocks. Kids can choose stocks of publicly traded companies that they like, follow and want to support. Names like Disney or Mattel can help kids understand how stocks relate to their real worlds.
Bonds. For those who prefer lower risk and steady income, bonds might be a better and safer security for a kid’s portfolio.
ETFs. An exchange-traded fund is a good option for investors who may want to follow a specific industry or sector instead of one particular company, and they require less tending than individual stocks.
Other ways to save for kids
If an investment account isn’t the right fit for your family, you may consider the following products that can still help you save for your child’s future.
529 college savings plans
A 529 college savings plan is a state-sponsored program that’s best for families who have a college-bound child and prefer a preset investment strategy. Your investment account is earmarked for your child’s higher education expenses, including tuition, fees and dorm costs. And as of December 2017, the Tax Cuts and Jobs Act allows you to use up to $10,000 per year to pay for tuition for elementary or secondary schools.
Shop around from state to state. All 50 states have at least one type of 529 college savings plan, and only a few have residency requirements. Some states like Arizona and Kansas even offer a state income tax break if you contribute to another state’s 529 plan. So you can shop around for a plan that caters to your investing style.
Tax advantages. Your earnings are not subject to federal income taxes, and when used for qualified education expenses, including fees, tuition and books, the withdrawals are also federal income tax-free. And most states offer some form of tax relief, generally in the form of tax credits or a deduction, on your contributions.
Switch beneficiaries. Although a 529 plan can’t have multiple beneficiaries, you can change your beneficiary to an eligible family member, such as a younger sibling, without penalty. And as of December 2019, the SECURE Act also gives you the option to apply up to $10,000 towards a qualified student loan.
No annual contribution limit. You can contribute as much as you want per year towards a 529 college savings account, although amounts over $15,000 are subject to federal gift tax, and each state sets its own maximum total contribution amount.
No income or age restrictions. You may contribute to a 529 plan no matter how much you make or the beneficiary’s age.
Potential account requirements. Your state may require an initial minimum contribution or monthly contributions.
May affect federal student aid. A 529 plan can increase your child’s Expected Family Contribution (EFC) on their Free Application for Federal Student Aid (FAFSA) and potentially reduce federal aid, including grants, work-study programs and subsidized loans.
Penalties. If you use the distributions for noneducational expenses, you’ll need to pay income taxes on the withdrawal, which may also be subject to a 10% penalty.
How to sign up
Find a plan. Shop around to find a 529 plan that works best for you by comparing costs, potential returns on investments and tax benefits.
Open an account. Fill out the necessary paperwork to establish a custodian and beneficiary.
Fund the account. You can transfer money into a 529 plan in several ways, including mailing a check, setting up automatic contributions or rolling over another 529 plan or education savings account.
Choose your investment portfolio. Consider your risk appetite and how aggressive you would like your portfolio to be. For example, some plans offer age-based investment options that adjust how risky your investments are as your kid approaches college age.
Education savings account
A Coverdell education savings account (ESA) is similar to a 529 college savings plan because it helps you save and grow your cash for future educational expenses. While you can choose your securities, it comes with more restrictions than a 529 plan.
Investment options. Most ESAs allow you to choose any investment you’d like, including stocks, bonds and mutual funds.
More qualified educational expenses. You can use these funds to cover tuition and fees for both higher education and from Kindergarten to grade 12.
Tax benefits. Earnings and withdrawals are tax-free if you use them for qualified expenses.
Ability to transfer account. You can rollover your ESA to another ESA if you want to switch the beneficiary to another family member who has not yet turned 30 years old.
Contribution limit. You can only contribute up to $2,000 per child per year.
Age restriction. You can’t contribute once the beneficiary turns 18 years old, and your kid must use the money before age 30.
Income limits. You can’t contribute to an ESA if you make over $110,000 — or $220,000 for married couples filing jointly.
May affect federal student aid. Similar to 529 plans, an ESA can impact your child’s financial aid eligibility.
How to sign up
Find a brokerage. Compare companies to find a firm that offers the right investment options and fees for your family.
Open an account. Complete an application to establish an education savings account in your child’s name.
Fund the account. ESA contributions must be made in cash.
Select your investments. Choose how you want to invest the money.
Debit cards for kids
Opt in for a debit card to teach your children how to manage their money. Some cards offer chores and allowance features to help kids safely earn and save their hard-earned dough, while others help build credit.
Parental controls. Keep track of your kid’s spending and set limits when appropriate.
Financial literacy. Help teach your kids about responsible spending and the importance of savings with prepaid debit cards.
Safety. Quickly lock your child’s debit card if it’s misplaced.
Pay allowances. Many cards allow you to assign chores and deposit allowances into your kid’s account.
No interest. Most debit accounts don’t pay interest.
Not a checking account. The majority of kid debit cards are prepaid cards or linked to your banking information. Your child’s debit card generally doesn’t come with a checking account.
Fees. Accounts may come with out-of-network and overdraft fees.
Open an account. Complete the parent registration process to set up an account, including verifying your address and date of birth.
Fund the parent wallet. Many kid debit cards have a separate parental account to help offset fees and verify your funding source.
Transfer funds or set spending limits. If you opt for a prepaid card, you can fund the account with a one-time payment or set up recurring payments for allowances. If the card is linked to your checking account, set limits on how much your child can spend and withdraw at ATMs.
Compare trading platforms that offer UGMA accounts
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Disclaimer: The value of any investment can go up or down depending on news, trends and market conditions. We are not investment advisers, so do your own due diligence to understand the risks before you invest.
It’s never too late to teach your kids about money management and how to save and invest for the future. Compare investment accounts to find the right option to grow your family’s hard-earned cash.
Kimberly Ellis is a writer at Finder. She hails from New York City with a BA from Queens College and a New York State teaching certificate. After teaching in both public and private schools, Kimberly decided to take the world by storm and dive into the media industry — where she covers everything from home loans and investing to K–12 education and shopping. She’s also an aspiring polyglot, always in a book and forever on the hunt for the perfect classic red lipstick.
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