Invest as a Minor + Custodial Accounts and How They Work

Invest as a Minor + Custodial Accounts and How They Work

How parents can start investing for their teens

Parents can play a vital role in helping their teens to start investing. The best way they can do that is to encourage them during every step of the process. If you’re already an experienced investor, show them the ropes. If not, learn alongside them.

Guide them in discovering their investing identity, which might be quite different from your own. Your teen has decades of investing ahead of them, while you have a shorter remaining investing time horizon. They can afford to take on more risk, including investing in some individual stocks that pique their interest, even if it might be a bumpier road. Encourage them to find what interests them the most so that they’ll stick with investing when times get tough, which we all know eventually happens.

Help them set up their brokerage account, but don’t do it for them. You want them to take ownership and initiative so that they continue investing. Also, it wouldn’t hurt to get them started with a gift deposit in their brokerage account. You could even offer to match a portion of their future deposits for a few years, much like a 401(k) company match.

The role time plays in compounding gives teens an advantage, so parents should encourage their teens to get started as soon as possible. They might complain at first, but they’ll eventually thank you for helping to get them on the path toward financial freedom.

How to Invest As a Teenager or Minor: Final Thoughts

Investing as a teenager has never been easier. However, if you are under age 18 then you may need the assistance of a parent or guardian. Whether you are trying to save for retirement, education, or your future, there are many options available for teenagers.

These include brokerage accounts, bank accounts, education-focused accounts, and even retirement accounts. Don’t let your age keep you from getting a headstart on your financial future. 

If you’d like to learn more about investing basics check out our Beginners Guide to Investing in the Stock Market.

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Setting Up a Custodial Account UGMA/UTMA

Minor accounts, created in part by the Uniform Transfers To Minors Act and the Uniform Gift To Minors Act (UTMA/UGMA), are excellent options if you are investing for your teenager. You can establish these minor accounts and begin investing within them almost immediately. This money can be used for any purpose including education expenses as well as any other needs the child may have. 

The purpose of these accounts is to provide monetary benefits to teenagers and you can establish a custodial UGMA/UTMA account with a brokerage such as Firstrade.

The profit from these investment accounts will be taxed according to the child’s tax rate or potentially the parent’s tax rates if the child makes enough money and is subject to kiddie tax limitations.

Custodial UGMA/UTMA accounts are one of the excellent options for teenagers who want to begin investing. The parents have the final decision over the account until the child reaches 18 or 21 (depending on the State). 

At the age of majority, ownership of the account will be transferred fully to the child and the parent will no longer have any control over the account. The child will be free to cash out the account for whatever they please, so it’s important to talk with your child about the intended purpose of the account beforehand.

Special Considerations: Opening an IRA Account for a Working Child

If a child has already been earning an annual income and has previously filed their taxes, then they would be eligible to open an IRA account with their parent's help. But this is only for cases in which a child has claimed earned income for at least one year already because IRA accounts require that the account owner has earned income.

Parents can contribute the money to a child's Roth IRA as long as the child earned at least that much in income during the year.

Can Minors Invest In Mutual Funds?

Minors can invest in Mutual Funds with the help of a guardian. The minimum age to invest in mutual funds in India on one’s account is 18 years. There is no specification for a maximum age to invest in mutual funds in India.

Apart from the procedural steps discussed earlier, one must keep the following points in mind:

  1.  Documents required for a minor’s investment in a mutual fund would be either of the following: Birth certificate, mark sheet, or leaving certificate from the HSC board of respective states, ICSE, CBSE, etc., minor’s passport, or date of birth proof.
  2. As per AMFI regulations, in case of modification in the minor’s guardian, because of a mutual decision between the parents or because of the death of the current guardian, one would require these documents:
  3. Form for modification in the guardian in the MAM Application form together with KYC and PAN of the newly appointed guardian.
  4. A letter of consent from the existing guardian, in case the cause is not the guardian’s demise.
  5. Certificate of Death, in case applicable.
  6. Name and signature of the newly made guardian should be registered with the bank account of the minor.
  7. When the child becomes a major, they need to apply for the same in the MAM form and the specified documents. Before submitting the MAM form, the unitholder should obtain a PAN, satisfy the KYC requirements, change the current bank account status, or open a fresh bank account. A fresh SIP, STP, SWP mandate in the prescribed form (to continue the SIP, STP, SWP, if applicable.) The account shall be frozen till the procedure is completed.

4. Tell Your Teenagers to Try Out Index Funds

Most teens love instant gratification. And learning how to invest isn’t always appealing. So to ensure they remain engaged, allow them to have more control over their investments. While tech stocks are fascinating for many teens, index funds offer a few other benefits.

Investing in a single company causes you to feel every high and low the company experiences. So instead, encourage your teen to invest in index funds.

They’ll still get exposure to their favorite companies. They just won’t be tied to one single investment, as the experts at U.S. News discuss.

This is important. And it can make a huge difference, not only in your teen’s success but also in their attitude towards investing.

If you’re not savvy about how to diversify your stocks, that could also be an issue. Can you offer your teen advice to prevent them from dealing with significant stock problems in the future? If not, definitely consider talking to them about index funds.

I recommend putting at least half of your invested dollars in index funds. This way, your teen can feel what it’s like to invest, without all the risk.

Investing in Your Child: One Last Thing You Should Know

No matter how you plan on investing for your child’s future, it’s important to sit down with your kids when they’re old enough and share your heart behind your gift. Clear communication about the expectations for this money can save you from dealing with family drama around the dinner table during Thanksgiving!

Giving an immature high school or college grad access to thousands of dollars is like handing over the keys to a Ferrari to someone who just passed their driver’s test yesterday. You’re setting them up for a nasty crash. If you want your financial gift to be a blessing and not a curse, make sure you’re teaching your kids the value of hard work and responsibility. They should have the character, maturity and wisdom to be a good steward of the financial gifts you’re entrusting to them.

6. Get Them to Invest in a Business

For a more exciting approach to investing, consider investing in a business. But as a parent, be careful. Make sure nobody tries to get your teen to invest in a business that is only designed to take advantage of people. This happened to me in college with a shady “t-shirt for credit card application” business.

With proper vetting, though, investing in a business can be very exciting. Whether they decide to open their own business or have researched businesses owned by family members or friends, investing in a business makes everything personal and is an excellent way for your teen to want to learn about business and investing quickly.

While I do believe failure is a great way to learn, you want to make sure your teen isn’t setting themselves up for failure by investing in a business that isn’t sustainable.

I think the cost of investing in individual businesses can be too high for some teenagers. So you as the parent need to be willing to act as the voice of reason, when necessary.

This can be difficult. But making sure your teenager is investing responsibly is essential and will allow you to help protect them before they make a huge mistake.

Investing for Your Childs Future Retirement

Some of you are thinking much further ahead and wondering how you can give your kids a head start on retirement. That’s great! It’s never too early to save for retirement.

But, here again, priorities are important. If your child is earning money,they should use some of it to save for college first before they worry about retirement. Having a few thousand bucks in an IRA isn’t going to do your kids much good if they graduate from college with a bunch of student loan debt hanging around their necks.  

That being said, you could open a Custodial IRA in their name if your teenager is making some money delivering pizzas or mowing lawns. Then, you would manage the account until they’re either 18 or 21 (depending on what state you’re in). With a Custodial IRA, you can open a traditional or Roth IRA, but we recommend the Roth IRA. That way, their retirement savings will grow tax-free.

Now, there is a catch: your child must bring in some kind of earned income in order for you to open an IRA in their name, and allowances don’t count! Plus, they (or you) can’t contribute more than what they make that year. So if your teenager makes $1,000 as a tutor this year, they can’t put more than $1,000 in their Custodial IRA. But don’t underestimate the power of small contributions.

Setting just a few dollars aside each month can help your teen get a jump start on their retirement savings and experience the power of compound growth!

Age

Money Invested

Account Balance

16

$2,400

$2,524

17

$2,400

$5,341

18

$2,400

$8,484

19

$2,400

$11,991

20

$2,400

$15,903

21Contributions to the Custodial IRA stop.

$0

$17,743

22

$0

$19,796

30

$0

$47,536

40

$0

$142,093

50

$0

$424,739

60

$0

$1.27 million–Your child could reach millionaire status.

Retirement (Age 65)

Total Amount Invested 

Total Account Balance

$12,000

$1.97 million

Let’s say you’ve done really well with your money, and you’ve built up a college fund for your 16-year-old daughter. Awesome! Now you want to open up a Custodial Roth IRA for her because she is making bank babysitting on the weekends to earn some cash. She wants to put some of her earnings into the Roth IRA, and you agree to “match” up to $100 each month. (Remember, she can’t put in more than she’s making, so she’s bringing in at least $200 a month.) So when your daughter invests $100 into the account, you also put in $100.

That means $2,400 will go into her Custodial IRA each year for five years until she turns 21 and the account transfers to her completely. With an average annual rate of return of 11%, she’ll have almost $16,000 in the Roth IRA when she takes over the account.

What would happen if your daughter just let the account sit there and didn’t put in another dime? Well, if the mutual funds in the account continued to grow at the same rate of return, she would have close to $2 million waiting for her when she retires around age 65!

And since you chose the Roth IRA, which grows tax-free, she won’t be taxed when she takes money out of the account. 

Opening an Investment Account for Teens

If your child is under 18 years old, the most effective way to start investing for or with them is to open a custodial account. With this type of account, an adult “custodian” opens an account and can save and invest money on behalf of the child. Then, when the child reaches adulthood—either 18 or 21, depending on the state—they’ll take full control of the account.

“Keep in mind, assets in a custodial account legally belong to the child—the account beneficiary,” Jessee said. “The parent or custodian is merely a placeholder until the child reaches legal adulthood. This means that if a parent puts money in a custodial account for a child, it is considered an irrevocable gift and cannot be taken back. In other words, that money now belongs to your child.”

There are two common types of custodial accounts: Uniform Gifts to Minors Act (UGMA) accounts and Uniform Transfers to Minors Act (UTMA) accounts. The two are almost identical but vary in the types of assets they can hold. UGMA accounts can hold financial assets like stocks, bonds, mutual funds, and cash, while UTMA accounts can hold all of those same assets as well as physical assets like real estate.

Another type of custodial account is a custodial individual retirement account (IRA), which allows teens and their parents to start saving for retirement before they reach adulthood. Similar to a UGMA or UTMA account, an adult custodian opens the IRA on behalf of a minor. Then, the family can contribute up to the child’s earned income for the year or up to $6,000, whichever is less.

In Whose Name Are Custodial Accounts Taxed?

Withdrawals or capital gains tax liabilities are taxed in the child's name—not the parent's. This can be an advantage over the guardian account (in which taxes fall under the parent's name, at their marginal tax rate) because children often pay little to no taxes due to their typically low annual incomes.

Consider Taxes & Fees

notYour account will not be tax-exempt. But it will be taxed at your tax rate. This is usually a good thing since you’ll probably have a much lower rate than your parents.

Here’s the tax liability if you’re under 19 years of age:

  • The first $1,050 of investment income is tax-free.
  • The next $1,050 is taxed at 10%.
  • Any income in excess of $2,100 is taxed at your parent’s marginal tax rate, which could be as high as 37%. This is what is often referred to as the “kiddie tax.”

My Story

I know when I was in high school, my parents showed me and gave me access to several UGMA accounts that were opened in my name by my grandparents when I was a baby. For the most part, that money sat there and my parents didn’t do anything with it. However, they taught me how to track the performance of the funds, and helped me set up Quicken for the first time. I was hooked on personal finance ever since.

I strongly recommend getting starting investing in high school, even if you only have $100 to start. Understanding by doing it is so important. It also put me on the track to financial independence in my 30s. 

The earlier you can start investing, the better it will be for your children to learn how to build wealth.

What are your thoughts on getting started investing in high school?

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