Do you want to teach your kids about the importance of financial planning? Opening investment accounts for your kids can be a great way to help them understand the value of long-term investments.
Early investing can also help grow an education fund to reduce the need for student debt after high school. There is enormous value in opening an investment account on your child’s behalf.
While children under the age of 18 have limited options when it comes to opening an investment account, you can open a custodial or joint account on their behalf. We’ve pooled together the best investment accounts for kids to help you choose the best one for you and your child’s future.
5 Best Investment Accounts for Kids
- Custodial Brokerage Account
- 529 Plans
- Custodial IRA
- Coverdell Education Savings Account (ESA)
- UGMA/UTMA Trust Account
1. Custodial Brokerage Account
A brokerage account is a garden-variety investment account. These accounts allow you to invest in stocks, securities, bonds, and index funds. These accounts can earn dividends and face fewer restrictions when withdrawing your funds, i.e., selling your shares. If you would like to teach your child about the stock market, you can open a custodial brokerage account for them.
Opening a custodial brokerage account is an excellent opportunity to get your kids excited about investing. Many brokerage firms offer simple brokerage accounts that are great for kids. They often charge minimal fees and are ideal for the buy-and-holder investor. You can open a custodial brokerage account on your child’s behalf, and transfer it to them when they turn 18 or 21, depending on the state.
The main benefit of a brokerage account for your child is that they can earn dividends depending on the company. Plus, there are usually fewer penalties when you withdraw from the account when compared to an IRA.
Brokerage accounts are an excellent way for parents and children to learn about investing in stocks, bonds, index funds, and securities together. Picking out your child’s investments together will help them feel engaged in the process and invested (pun intended) in their account growth.
🏆 Our Pick for a Custodial Brokerage Account: Ally Invest
Ally Invest provides commission-free trading, sophisticated research tools, and 24/7 connection with market resources to help you analyze your portfolio from wherever, whenever.
When you get started, you can earn as much as $3,000 in bonuses – no account minimum necessary.
2. 529 Plans
If you’re interested in opening an investment account to save for your child’s education, a 529 plan may be a great choice for you. A 529 plan is a tax-advantaged saving account specifically designed for your child or beneficiary’s education.
529 plans are like a Roth IRA in that your contributions are tax-deferred until you begin to withdraw. Unlike some education savings plans, 529 plans offer high contribution amounts, which limits your tax liabilities when you decide to liquidate the account. You can make withdrawals for anything that is meant for education, including:
- Room and board
- Expenses from K – 12
If saving for education expenses is the goal for your child’s account, there are two types of 529 plans for you to consider:
College Savings Plan
If you would like your 529 plan to grow through investments, you should consider a college savings plan. College savings plans work similarly to an IRA or 401(k) account. Each contribution will be funneled into investment vehicles, such as index funds. As your child gets closer to college, the investments will become more stable so that you can withdraw what you need from the account.
529 plans are administered at the state level, meaning contribution limits can vary. Generally, federal gift limits allow up to $17,000 in gifts before they are subject to taxation. Anyone can contribute to your child’s 529 plan, which means grandparents and relatives can help you save for your child’s future.
Prepaid Tuition Plan
If you’re concerned about the rising cost of education, prepaid tuition plans can help you plan ahead. Prepaid tuition plans allow you to lock in today’s price for college tuition and redeem it within 18 years when your child attends university. Essentially, students and parents can avoid paying tuition increases over time at participating colleges and universities.
Prepaid tuition plans are a great strategy for families to save on college tuition expenses. However, these plans are not available in every state, so you will need to check with your state or employer to see if this is an option for you.
🏆 Our Pick for a 529 Plan: Fidelity
Fidelity is a national investment firm, which means that almost anyone can open a 529 plan account through them regardless of the home state. When you open a 529 plan account through Fidelity, you won’t pay any annual fees or be subject to account minimums. You can also choose to invest in an age-based or custom strategy.
Many 529 plans are offered at the state level, so we encourage you to explore your state’s options to ensure you’re opening an account that best meets your needs.
3. Custodial IRA
Custodial IRAs are an excellent way to help your child save for retirement, college, or any other significant expenses they may face. Like a custodial brokerage account, a custodial individual retirement account (IRA) is owned by the beneficiary but managed by a guardian until the child reaches the age of 18.
Opening an IRA can give your kid a significant head start on saving for retirement or other life expenses by investing in stocks, bonds, and securities. There are two primary types of IRAs to consider opening on your child’s behalf: traditional IRA or Roth IRA.
Traditional IRAs allow you to deposit pretax dollars to a retirement account. Because you avoid paying taxes at the time of contribution, you will pay taxes on your account balance when you withdraw your money. If you withdraw too early (before age 59 and a half), you could face penalty fees.
Traditional IRAs are ideal for people who want to reduce their tax rate on their income, i.e., higher earners. If your teen is contributing to the IRA account with their own income, they likely aren’t earning enough to be concerned about reducing their income tax. However, if you’re using your own IRA to pay for your kid’s education, a traditional IRA might be a good one to consider.
In terms of taxes, Roth IRAs work opposite to traditional IRAs. You contribute to a Roth IRA after taxes, but you will enjoy tax-free benefits while the money is in your account and after you withdraw from the account. However, you will face similar penalties to a traditional IRA if you withdraw the funds from your account before the age of 59 and a half.
Custodial Roth IRAs are the most popular retirement account for parents because they reduce the tax burden the beneficiary will face when they choose to withdraw from the account. Many parents opt to open Roth IRAs for their children because teens’ earned income has fewer tax responsibilities. Placing after-tax funds in the account now will mean they will enjoy tax-free withdrawals later in life.
🏆 Our Pick for a Custodial IRA: Charles Schwab
Charles Schwab is an industry leader in investment and retirement savings for a reason. Their custodial account has only a $100 minimum for opening and doesn’t charge any account fees.
Account holders will benefit from 24/7 access to tax advisors, customer service agents, and a user-friendly platform that lets you view your balance, review investments, and ask questions.
4. Coverdell Education Savings Account (ESA)
A Coverdell education savings account (ESA), like a 529 plan, is a helpful way to start saving for your children’s education. Contributions to a Coverdell ESA will grow tax-free, and withdrawals are tax-free so long as they are used for qualifying educational expenses. This type of account is popular due to its favorable federal tax treatment.
Although many account holders use their Coverdell ESA to save for college expenses, your account balance can also be used for K-12 expenses. If you plan to send your child to a private school, you can use this account to help pay for tuition and supplies. If you use the funds for any non-qualifying expense, you will face a 10% penalty fee and potentially a capital gains tax.
The main drawback of Coverdell ESAs is that they have strict contribution limits. The maximum that you can contribute is $2,000 annually per beneficiary. Higher-income households have a reduced contribution limit and may be ineligible for a Coverdell account altogether. All contributions to a Coverdell ESA must be made before the child reaches 18.
🏆 Our Pick for a Coverdell ESA: TD Ameritrade
As an institution, TD Ameritrade prioritizes education and customer support, so they are a solid choice for parents who want to know more about their account and how to manage it.
TD Ameritrade’s Coverdell ESA requires no minimum to open and has the standard $2,000 annual contribution limit. You can grow your balance by investing in various products, like stocks, bonds, and mutual funds.
5. UGMA/UTMA Trust Account
The Uniform Gift to Minors Act (UGMA) and Uniform Transfers to Minors Act(UTMA) are custodial trust accounts that can help you build a sizable nest egg for your child’s future. Like other custodial accounts, a parent or relative can open an account on a child’s behalf and controls it until the beneficiary reaches the age of majority for their state. From there, the beneficiary will manage the account to do with it what they wish.
With UGMA/UTMA accounts, a custodian (typically a parent or grandparent) can contribute money to an account and choose a type of investment strategy to grow the account balance. The custodian and other family members can make substantial contributions to the account without triggering a gift tax. These amounts are usually $16,000 for individual contributors and $32,000 for married couples.
There are two main differences between UGMA and UTMA custodial accounts. UGMA custodial accounts are made to hold financial assets, including mutual funds, exchange-traded funds (ETFs), stocks, and fractional shares. On the other hand, UTMA custodial accounts are meant to store these assets and any property, like real estate. Additionally, UTMAs are not available in every state, with South Carolina and Vermont being the exceptions.
Like any investment account for kids, opening a UGMA/UTMA account has benefits and drawbacks over other investment accounts. UGMA/UTMA accounts have more flexibility than education savings accounts, which means you can use the funds to pay for other expenses besides school. However, you will not have as many tax benefits as you would with a 529 plan. Additionally, you may face some challenges if you plan to apply for financial aid when your child goes off to college.
🏆 Our Pick for a UTMA/UGMA Account: Vanguard UGMA/UTMA
The Vanguard UGMA/UTMA account offers several high-performing, low-cost investments to help you grow your account balance. Their broad lineup of investments includes ETFs, stocks, bonds, mutual funds, and more. Plus, self-directed clients will not pay any enrollment, transfer, or adviser fees.
Why You Should Open an Investment Account for Your Kids
Teaching your kids financial literacy begins with exposing them to personal finance concepts early in life. Start by opening a bank account and debit card for your kids, and then start a conversation about opening a youth account to allow them to explore investment options.
If you help your children build an investment portfolio while they’re young, they will have a better chance of reaching their financial goals later in life. Here are three reasons why opening an investment account for your kid is an excellent idea.
Teaches Them the Basics of Investing
Many parents open an investment account for their children for educational purposes. There are plenty of adults who don’t have any investments because they aren’t sure how the stock market works. Allowing your kid to choose their own assets will help them learn about the benefits of investing and build a strong foundation for their financial future.
Maximizes the Time Their Money Can Grow
If you open an investment account for your kids, you will benefit from compound growth from now until the time they leave for college. Even small contributions over the years can add up to big savings thanks to compound interest. Starting early maximizes the time you can benefit from the annual percentage yield on the account.
Prevents Debt Early In Life
If you can help your kid avoid debt early in life, they will thank you for it. Student and credit card debt are among young adults’ biggest debt concerns. Getting your kids into investing while they’re still young will help them overcome financial hurdles as students and young professionals.
Frequently Asked Questions
How old does my child have to be to buy stocks?
Your child will need a brokerage account to begin investing in stocks. Many brokerages require that you be at least 18 years old to open one, but you can open a joint account with them.
Does the money I put in my child’s account get taxed?
There are various tax implications to opening an investment account on your child’s behalf. If you contribute unearned income, i.e., money your kid did not earn, you could incur gift taxes. Most plans are subject to gift tax, which means you could get dinged if you contribute more than $16,000 to the account. Consult a tax advisor if you have questions about taxes on your child’s account.
Can you withdraw money from a custodial account?
If you withdraw money from a custodial account, it must be for the benefit of the beneficiary. This means that you cannot withdraw from the account to cover your own expenses or debts. Even if gifted, you cannot take back any of the assets for your own use.