Can I Start an Investment Account for My Child?

Establishing investment accounts for children is a beneficial goal. Starting early allows investments to grow over many years, providing a significant financial advantage for their future. This can build a strong financial foundation for educational pursuits, a first home, or financial independence. Investing for a child also teaches financial responsibility and the power of long-term savings.

Understanding Account Types for Children

Several investment account types are available for children, each with distinct features regarding ownership, control, and tax implications. Understanding these differences is crucial for selecting the most suitable option.

Custodial brokerage accounts, established under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), allow an adult to manage assets for a minor. UGMA accounts typically hold financial assets like cash, stocks, and mutual funds. UTMA accounts offer broader flexibility, permitting various assets including real estate. The custodian makes all investment decisions until the child reaches the age of majority, which varies by state (typically 18-21, or up to 25). Control of the assets then irrevocably transfers to the child, who can use the funds for any purpose.

Contributions to UGMA/UTMA accounts are irrevocable gifts to the child and cannot be reclaimed by the donor. While there are no federal limits on contributions, amounts exceeding the annual gift tax exclusion ($18,000 per donor per recipient in 2024) may require the donor to file a gift tax return. Earnings are subject to “kiddie tax” rules: the first $1,300 of a child’s unearned income is tax-free, the next $1,300 is taxed at the child’s rate, and income above $2,600 is taxed at the parent’s marginal tax rate. Withdrawals must be used for the child’s benefit, with no penalties, only tax implications on earnings.

The 529 plan is designed for education savings, offering tax-advantaged growth. Withdrawals are tax-free at the federal level when used for qualified education expenses. Qualified expenses include tuition, fees, books, supplies, equipment, and room and board for students enrolled at least half-time. The account owner, usually a parent, maintains control and can change the beneficiary to another qualified family member without tax consequences.

Contributions to 529 plans are made with after-tax dollars and have no federal contribution limits, though state plans may have overall caps. The primary benefits include tax-deferred growth and tax-free withdrawals for qualified educational expenses. Non-qualified withdrawals may subject the earnings portion to income tax and a 10% penalty.

For children with earned income, a custodial Roth IRA is a long-term savings vehicle. This account allows after-tax contributions to grow tax-free, with qualified withdrawals in retirement also being tax-free. A child must have earned income from a W-2 job or self-employment to contribute. The maximum contribution for 2024 is $7,000, or 100% of the child’s earned income, whichever is less.

Contributions to a custodial Roth IRA can be withdrawn tax-free and penalty-free at any time, as they are made with after-tax dollars. Earnings withdrawals are tax-free only if the account has been open for at least five years and the account holder is age 59½ or older, or if certain exceptions apply. These exceptions include up to $10,000 for a first-time home purchase or withdrawals for qualified higher education expenses, though the earnings portion may still be taxable if the five-year rule is not met. The custodian manages the account until the child gains full control at the age of majority.

Steps to Open an Investment Account

Opening an investment account for a child requires gathering necessary information and completing an application with a chosen financial institution.

Parents or guardians need to collect essential personal information for themselves (as custodian or owner) and the child beneficiary. This includes full names, dates of birth, Social Security numbers, and contact information. Employment information for the parent may also be requested.

Required documentation includes a government-issued identification for the parent, such as a driver’s license, and the child’s Social Security card or birth certificate. Many financial institutions offer online applications.

After submitting the application, the financial institution provides an account number and instructions for online access. Funding the new account can be done by linking a bank account for electronic transfers or initiating a transfer of cash or securities. When selecting an institution, consider fees, investment options, and educational resources.

Key Financial and Control Considerations

Beyond opening an account, financial planning and control aspects warrant consideration when investing for a child. These factors influence financial aid eligibility, tax obligations, and the ultimate use of invested funds.

Financial aid impact, particularly for the Free Application for Federal Student Aid (FAFSA), is a key consideration. Assets in a child’s name, such as UGMA/UTMA accounts, are assessed more heavily than parental assets when calculating the Student Aid Index (SAI). Student assets can substantially reduce financial aid eligibility. Conversely, 529 plans are treated as parental assets on the FAFSA, which has less impact. Qualified retirement accounts, like IRAs, are not reported on the FAFSA.

Contributions to investment accounts for children have gift tax implications. The IRS allows individuals to give up to the annual gift tax exclusion without triggering reporting requirements. If a gift exceeds this, the donor must file a Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return, though actual gift tax liability typically arises only after exceeding a larger lifetime exclusion amount.

The transfer of control over custodial accounts (UGMA/UTMA) at the age of majority is important. While the custodian manages funds during the child’s minority, assets become the child’s property once they reach the specified age (commonly 18 or 21, varying by state). At this point, the parent loses control, and the child can use the funds for any purpose. This potential for unrestricted access necessitates considering the child’s financial maturity.

529 plans offer flexibility to change the beneficiary. If the original beneficiary does not pursue higher education, receives scholarships, or has leftover funds, the account owner can change the beneficiary to another eligible family member without taxes or penalties. This allows for adaptability in education planning.