Starting a child down the path to financial independence early is a good idea. Just keep in mind the things they can't do on their own, like open a brokerage account. A minor person under age 18 may have a brokerage account with their own name attached to it—if a parent or guardian is involved. There are a few different ways this can happen.
A parent or guardian of an underage child can open a guardian account for the child. The assets in the account, as well as the capital gains and tax liabilities the account produces, belong to the parent. In this situation, the parent has total ownership and control. Attaching the child's name brings no legal standing.
- A custodial brokerage account allows adults to open a brokerage account for a minor.
- Parents can't open an IRA account in a child’s name; a child can open one when they start earning taxable income.
- Families can open custodial accounts to save for college, and some have no minimum balance.
- Custodial accounts, in general, can be opened at financial institutions including banks, investment brokerages, and credit unions.
- Check with your financial institution to see if they participate.
Opening a Custodial Account
Another way a child can have a brokerage account in their name is through what is called a custodial account. In this type of account, the child owns the assets contained within the account, but the parent has control of investment decisions and withdrawals.
However, it's important to note that with this type of account, withdrawals or capital gains tax liabilities are taxed in the child's name—not the parent's. Of course, 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.
Minimum account balances and interest rates vary by company. Anyone can contribute to the custodial account. When the minor reaches adulthood, account ownership transfers from the custodian to the minor; however, when the minor reaches adulthood, the minor can decide when and how to use the money.
Many (but not all) brokers offer custodial IRA accounts. Firms that currently offer accounts for minors include Charles Schwab, E*TRADE, Fidelity, Merrill Edge, TD Ameritrade, and Vamguard, among others.
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.
Example of a Custodial Account
There are two types of custodial accounts: the Uniform Transfers to Minors Act (UTMA) and the Uniform Gift to Minors Act (UGMA) accounts. They differ in terms of the types of assets one can contribute.
Friends and family may contribute up to $16,000 per child in 2022 ($17,000 in 2023) free of gift-tax consequences to a child's UGMA/UTMA account. Couples can contribute $32,000 in 2022 and $34,000 in 2023.
A UGMA account can include cash, stocks, mutual funds, or insurance policies. A UTMA account is more flexible and may include any type of asset, including works of art, real estate, or even intellectual property such as royalties from a book.
What Types of Brokerage Accounts Can a Parent or Guardian Open for a Child?
The two types of custodial accounts are the UTMA and UGMA. They differ in terms of the types of assets one can contribute: a UGMA account can include cash, stocks, mutual funds, or insurance policies, while a UTMA account may include any type of asset, including works of art, real estate, or even intellectual property such as royalties from a book.
How Can a Child Have a Brokerage Account in Their Name?
A custodial account permits a child to own the assets in the account. Still, a parent has control of the investment decisions and any withdrawals which might be made. Withdrawals or capital gains tax liabilities are taxed in the child's name—not the parent's.
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.
What Is the Best Investment Plan for a Child?
This will depend on your goals for your child. If you wish to teach them about long-term buy-and-hold investing, a diversified portfolio of index ETFs or a robo-advisor may be the best approach. To teach about trading and picking stocks, you can also encourage some speculation using a small amount of money that you and your child can afford to lose.
How Can I Make a Minor a Beneficiary of My Retirement Account?
Until age 18, you cannot legally name a child as a primary beneficiary of a retirement account. You can, however, establish a trust in their name and then name the trust as the beneficiary. You would also have to name a trustee (someone over 18) to oversee the funds until the children reach legal age.
The Bottom Line
Every state in the union allows for UGMA accounts. These two types of custodial accounts are created in a child's name with the guardian or parent acting as custodian.
Age limits for accessing the accounts are on a state-by-state basis for a UTMA but are typically anywhere from 18 to 24 years of age. Minors may not be able to open their own brokerage accounts, but family and friends can help them set up custodial or guardian accounts, and when a child begins to earn income (for at least one year), they can open an IRA.