Investing for Kids: How to Get Your Minor Children Started With Investing
Four Steps for Starting Your Kids on Their Investment Journey
In many families, kids are granted an allowance or earn money for doing chores, plus they’re likely to amass a bit of savings from birthdays and lost teeth, too. While most start out with a piggy bank and eventually move to a savings account with mom and dad’s help, consider the option of investing for kids. Opening an investment account in their name can be exciting, and it’s a great way to begin teaching them more about personal finance from a young age.
Now, the rules for minors surrounding investing are a bit different than they are for adults, but it’s relatively simple to get your kids started. They may only make a little bit of money, but it’s the education and experience that comes with early investing that is truly beneficial. After all, it’s young adults who begin investing for retirement with their very first paycheck who end up with a tidy nest egg that keeps them set for life.
So, if you’d like to set your kids up for financial success and teach them about investing in the process, you’ll want to take these four steps:
#1: Choose the Account Type
The Uniform Transfers to Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA) allows minors to set up savings, checking, or brokerage accounts. All that is required is that they have an adult – in this case, you, their parent – to sign on as the account custodian. In this role, you will have to approve what your child does with the money until age 18 or 21, depending on the state you reside in, but the money legally belongs to your child and can only be spent for their benefit. It’s worth noting that you cannot deposit $100 in your child’s account, then later decide to withdraw it or transfer it to another child’s account.
UTMA accounts can be set up in-person at a bank or a credit union, or online through a firm such as Vanguard. In either case, you’ll provide a bit of information and identification, and the account will be ready for you to help your child build their investment portfolio.
You could also choose to set your child up with a UTMA 529 plan. These tax-advantaged savings plans are meant to encourage savings for future education costs, so there are restrictions on how the money can be spent. Each state has at least one 529 plan available, but you don’t have to choose your own state’s plan. Most often, they will offer a variety of investment portfolio options, including mutual funds and exchange-traded funds.
If you want to go a bit less traditional, you could start your kids with micro-investing. It’s easy to set up a custodial account online with Stash or Stockpile, and you can use an app like BusyKid to digitally track the money your kids earn from chores or allowances.
An option that sometimes works for teens is a traditional or Roth IRA account. If your kids happen to be old enough to work and they have earned income from working, they qualify for this option.
Keep in mind that investment accounts often also require a checking account that links to the brokerage account, so you’ll likely need to open a checking account for your kids, too. Not only does the checking account make it easy to fund the brokerage account, but it’s where your children will receive dividends or other proceeds.
#2: Determine Your Investment Vehicles
Once you’ve chosen an account type and set it up, kids have access to the same investment products that adult investors do. They can choose from mutual funds, exchange-traded funds, or individual stocks. Their choices will likely depend both on their interests and on how much money they have to start with, as well as how actively or passively they wish to invest.
If your child has an interest in following a company or two in the news and making active investment choices based on what they learn, individual stocks may be the best option. In this case, look for a brokerage firm with no minimum initial deposit – or a low one – and low trade fees, too. Investing in individual companies can oftentimes feel the most exciting to kids, and it can certainly help them learn a lot. However, it’s important to teach them that, if they want to earn money over the long-term, most financial advisors recommend mutual funds over individual stocks because they carry less risk.
If individual stock investing feels overwhelming to your young investor, mutual funds like an S&P 500 index are a good option. You can usually find ones with low expenses, so your kids get to keep more of their investment, but they often require minimum investment amounts.
Exchange-traded funds are also an option for your kids. They work much like mutual funds, but they typically have lower minimum investments. They are a collection of securities and often track an underlying index, but they can invest in many varied industry sectors.
It’s also an option for your kids to invest in certificates of deposit or Treasury bonds, but the low-interest rates we’re seeing today make these less-exciting options for young investors excited to learn – and earn.
#3: Consider Tax Liability
Will your kids have to pay taxes on investment gains? Will they have to file their own tax returns? These are questions you’ll need to consider if your kids are investing, and the answer to both questions is… possibly.
These answers are easiest if a child earns less than $1,050 in investment income, in which case there is no need to report anything to the IRS. If the income is under $12,000, you can opt to report it on your own tax return or file a separate return for your child. Once your young investor reaches that $12,000 mark in investment gains, you’ll have to file a separate tax return for them.
When it comes to the tax rate a minor will pay, unearned income of $2,100 or less gets taxed anywhere from 0 percent to 10 percent. The exact rate will depend upon the type of income it is. Earnings above $2,100 get taxed at your rate regardless of whether you file together or separately.
One exception to the above is a UTMA 529 plan, where your child will never have to pay federal taxes on earnings so long as the money is spent on qualifying educational expenses, like tuition or books and supplies.
#4: Note Impact on College Financial Aid
While your kids can get a lot out of learning about investments from a young age, it’s important to note what their investment accounts could mean when it’s time to apply for college financial aid. When filling out the Free Application for Federal Student Aid (FAFSA), any assets in your child’s name will count against them – and more so than assets in a parent’s name. For this reason, it’s a good idea to encourage your kids to focus on more short-term goals for their investment earnings. Younger kids might set their sights on a new Lego set, while an older kid might set a goal of saving up to buy a car.
Now, a 529 account is the exception here again. Even if your child is the 529 account owner, financial aid officers will consider any funds in the 529 as a parental asset. This can be a gamechanger because only about 5 percent of parental assets will count against your child’s financial aid eligibility, whereas it increases to 20 percent for non-529 student assets.
Final Thoughts on Getting Your Kids Started with Investing
Opening and managing an investment account of their very own is one of the best ways to teach your kids real-life lessons about personal finance, money management, and the discipline required to focus on a goal. Early experience with investments also encourages your kids to think like an investor from the time they get their very first paycheck as an adult, meaning they are likely to start building their wealth much earlier than their peers.
If you plan to introduce investing to your kids, use the four steps above to guide you in getting started.