How to Buy a Stock for a Child

Investing in the stock market for a child can help build a financial foundation for their future. Many parents and guardians use this approach to provide a head start on financial independence, whether for college expenses, a home down payment, or a significant financial cushion later in life. Understanding the practical steps, from selecting the right account to navigating tax implications, is important for making such an investment. This article guides you through establishing and managing a stock portfolio for a minor.

Understanding Investment Account Options

When considering investing in stocks for a child, several account types offer distinct features. A common choice is a Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) custodial account. These accounts allow an adult custodian to manage assets for a minor until the child reaches the age of majority, which varies by state (typically 18-21). Once the minor reaches this age, they gain full control of the assets, which can include stocks, bonds, and mutual funds. Funds within these accounts are considered an irrevocable gift to the minor.

Another option, if the child has earned income, is a Custodial Individual Retirement Account (IRA). These can be Traditional or Roth IRAs. Contributions are limited to the child’s earned income for the year, up to the annual IRA contribution limit ($7,000 for 2024). A Custodial Traditional IRA allows for potential tax deductions on contributions and tax-deferred growth, with withdrawals taxed in retirement. A Custodial Roth IRA involves after-tax contributions but offers tax-free growth and tax-free withdrawals in retirement.

While primarily for educational savings, 529 plans can also hold stock-based investments through mutual funds or exchange-traded funds (ETFs). Unlike UGMA/UTMA accounts, 529 plans are geared towards qualified education expenses; non-educational withdrawals may be subject to income tax and a 10% penalty. The account owner, typically a parent, retains control over the assets and can change the beneficiary.

Preparing Required Information

Before opening an investment account for a child, gather specific personal and financial details. For the child beneficiary, you will need their full legal name, date of birth, Social Security Number (SSN), and current residential address.

The adult custodian or account holder also needs to provide their full legal name, date of birth, and Social Security Number. A current residential address and employment information, including employer name and occupation, are typically requested. To verify identity, a government-issued ID, such as a driver’s license, is needed, including its identification number and state of issuance.

For funding, bank account details, including routing and account numbers, are necessary for electronic transfers. If the account allows for additional beneficiaries (e.g., in certain 529 plans), their full legal name, date of birth, and Social Security Number are also needed.

Account Opening and Funding Process

After selecting the account type and gathering information, open and fund the investment account. Choose a financial institution, such as an online brokerage or traditional bank, that offers the custodial or educational savings account. Many online brokerage platforms simplify the application process.

The application process involves completing an online or, in some cases, a paper form. Input all prepared information for the child and custodian, including names, dates of birth, Social Security Numbers, and addresses. Review all entered data carefully for accuracy before submission to avoid delays. Some institutions may require electronic or physical signatures.

After application submission and approval (which can take hours to days), fund the new account. Common funding methods include electronic transfers from a linked bank account, often the quickest way. Other options include mailing a check, setting up recurring ACH transfers, or initiating a wire transfer for larger amounts. Initial funding activates the account for investment.

Stock Selection and Purchase

Once the investment account is open and funded, focus shifts to selecting stocks and executing trades. Most brokerage platforms offer research tools to identify potential investments. These tools often include company financial statements, industry news, and analyst ratings for performance insights. Utilizing these resources informs investment decisions.

Understanding different order types is important when purchasing shares. A market order instructs the broker to buy or sell shares immediately at the best available price. While ensuring prompt execution, the final price might fluctuate from the quoted price, especially in volatile markets. Conversely, a limit order allows you to specify the maximum price you will pay or the minimum price you will accept when selling. This provides more control over the execution price but does not guarantee the order will be filled if the stock does not reach the specified price.

To place a trade, navigate to the brokerage platform’s trading section, search for the stock by its ticker symbol, and specify the number of shares to purchase. After selecting the order type (e.g., market or limit), confirm trade details before submitting. Once executed, the brokerage sends a trade confirmation detailing the stock, shares, price, and any commissions. This confirmation serves as a transaction record.

Navigating Tax Considerations

Understanding tax implications is important for managing a child’s investment portfolio. UGMA/UTMA custodial account investment income, like dividends and capital gains, is subject to “kiddie tax” rules. For 2024, if a child’s unearned income exceeds $1,300, it is taxed at the child’s rate up to $2,600, then at the parent’s marginal tax rate for amounts above $2,600. This rule prevents parents from shifting investment income to children for lower tax brackets.

Capital gains and losses from stock sales have specific tax treatments. Short-term capital gains (from stock held one year or less) are taxed at ordinary income rates. Long-term capital gains (from assets held over one year) qualify for lower, preferential tax rates (0%, 15%, or 20% depending on income). Dividend income is categorized as qualified or non-qualified; qualified dividends are often taxed at the same preferential rates as long-term capital gains.

Custodial IRAs offer specific tax advantages. Traditional Custodial IRA contributions may be tax-deductible, with earnings growing tax-deferred until retirement, when withdrawals are taxed as ordinary income. A Roth Custodial IRA, funded with after-tax dollars, allows for tax-free growth and withdrawals in retirement, provided the account has been open for at least five years and the account holder is at least 59½, or meets other conditions. Early Traditional IRA withdrawals before age 59½ may incur a 10% penalty plus income tax, while Roth IRA principal contributions can generally be withdrawn tax-free at any time.

For 529 plans, growth is tax-free, and withdrawals are tax-free if used for qualified education expenses (e.g., tuition, fees, books, room and board). However, if not used for qualified educational expenses, the earnings portion is subject to federal income tax and a 10% penalty. Annually, parents or custodians receive tax forms from the brokerage or financial institution, such as Form 1099-DIV for dividends and Form 1099-B for brokerage proceeds, necessary for tax reporting.