How to Buy Stocks When You Are Under 18

The Foundation: Custodial Accounts

Individuals under the age of 18 generally cannot directly enter into contracts, which includes opening brokerage accounts to buy and sell stocks. This legal limitation necessitates an adult to establish a specialized investment vehicle on their behalf. The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) provide the legal framework for these accounts, allowing assets to be held for the benefit of a minor. These custodial accounts ensure that investments are managed by an adult until the minor reaches a specific age, typically between 18 and 25, depending on the state and the account type.

A custodial account designates two primary roles: the custodian and the minor beneficiary. The custodian is an adult, often a parent or grandparent, who has legal control over the account and is responsible for managing the investments in the minor’s best interest. The minor is the legal owner of the assets held within the account from the moment they are contributed.

While both UGMA and UTMA accounts serve the same fundamental purpose, they differ in the types of assets they can hold. UGMA accounts are generally restricted to financial assets such as cash, stocks, bonds, and mutual funds. UTMA accounts, on the other hand, offer broader flexibility, allowing for a wider range of assets, including real estate, intellectual property, and other tangible or intangible property. The custodian’s role is one of stewardship, managing these assets until the minor reaches the age of majority, at which point control transfers directly to the now-adult beneficiary.

Setting Up Your Custodial Investment Account

Research various brokerage firms that offer UGMA or UTMA accounts, as not all financial institutions provide both options. Evaluate potential firms based on their investment offerings, such as stocks, exchange-traded funds (ETFs), or mutual funds, and compare any associated fees, including trading commissions, account maintenance charges, or transfer fees, which can range from low to moderate depending on the firm and account activity. Additionally, assess the user interface and educational resources provided, as these can significantly impact the custodian’s ability to manage the account effectively.

Once a brokerage firm is selected, the custodian will need to gather specific personal information and documentation for both themselves and the minor. For the custodian, this typically includes their full legal name, date of birth, Social Security Number or Taxpayer Identification Number, current residential address, and a government-issued identification such as a driver’s license or passport. The minor’s information required will generally include their full legal name, date of birth, and Social Security Number.

Before completing the application forms, the custodian should make preliminary decisions regarding the account’s structure and initial investment strategy. This includes confirming whether a UGMA or UTMA account is more suitable based on the desired types of assets to be held and the state’s specific regulations regarding the age of majority for such transfers. Consider the initial investment strategy, such as setting long-term growth goals, assessing the appropriate risk tolerance for the minor’s investment horizon, and identifying suitable investment types that align with these objectives. Decisions about asset allocation should be made with the understanding that these funds are typically for the minor’s long-term benefit.

The application forms provided by the brokerage firm will request all the previously gathered information. These forms will typically ask for details about the custodian’s identity, contact information, and financial background, as well as the minor beneficiary’s identifying information. They will also include sections for selecting the account type (UGMA or UTMA) and, in some cases, initial funding instructions or investment preferences.

Managing and Transitioning Custodial Account Investments

After a custodial investment account has been opened, the next step involves funding the account to begin investing. Custodians can typically deposit funds through various methods, including electronic transfers from a linked bank account, direct deposits, or mailing a check to the brokerage firm. Some firms may also allow for recurring automatic investments, which can help establish a consistent savings habit for the minor’s future.

Once funds are available, the custodian can begin placing trades to buy and sell investments. This process usually involves navigating the brokerage firm’s online platform or mobile application, searching for specific stocks or funds by their ticker symbols, and then entering the desired number of shares or dollar amount to invest. The custodian is responsible for all investment decisions, ensuring they are made in the minor’s best interest and align with the established investment strategy.

The custodian has ongoing responsibilities that extend beyond initial funding and trading. These duties include maintaining accurate records of all transactions, monitoring the performance of the investments, and making periodic adjustments to the portfolio as needed. The custodian is also responsible for ensuring compliance with any regulations and managing the account according to the Uniform Gifts to Minors Act or Uniform Transfers to Minors Act guidelines.

Custodial accounts have specific tax implications that custodians must understand and manage. Income and capital gains generated within these accounts are generally taxable to the minor, but they may be subject to the “kiddie tax” rules. Under these rules, a portion of the minor’s unearned income exceeding certain thresholds is taxed at the parent’s marginal tax rate, rather than the minor’s lower rate. The custodian is responsible for ensuring that any necessary tax forms, such as IRS Form 8615 for unearned income of a child, are filed.

The final stage of a custodial account involves the transition of assets to the minor when they reach the age of majority. This age typically ranges from 18 to 21, but in some states, it can be as high as 25 for UTMA accounts. As the minor approaches this age, the brokerage firm will usually notify the custodian and the minor about the impending transfer. The process often requires the minor to complete paperwork to formally take control of the account, converting it into a standard brokerage account in their own name.

Sources

https://www.fidelity.com/learning-center/personal-finance/college-planning/ugma-utma-account
https://www.investopedia.com/terms/u/ugma.asp
https://www.investopedia.com/terms/u/utma.asp
https://www.irs.gov/taxtopics/tc559
https://www.schwab.com/brokerage/ugma-utma-account
https://www.nerdwallet.com/article/investing/ugma-utma-accounts