How to Invest When Under 18: Getting Started

Investing for individuals under 18 offers an opportunity to build a financial foundation early. While minors cannot directly own investment accounts, legal structures facilitate this process. These mechanisms allow adults to manage assets on behalf of a minor, fostering long-term growth and financial literacy. Understanding these avenues and the practical steps involved is a starting point for establishing investments for a younger generation.

Understanding Custodial Accounts

Custodial accounts are financial arrangements established by an adult for a minor’s benefit, allowing assets to be held and managed until the minor reaches a specified age. Minors cannot directly own investment assets due to legal restrictions, making these accounts a necessary vehicle for their investments. The two primary types are Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts.

UGMA accounts generally hold financial assets like cash, stocks, bonds, mutual funds, and life insurance policies, and are available nationwide. UTMA accounts offer greater flexibility, holding a broader range of assets including real estate and vehicles, in addition to financial assets. However, UTMA accounts are not adopted in every state.

The adult establishing the account, known as the custodian, manages the assets for the minor. The custodian makes all investment decisions, but the assets irrevocably belong to the minor once contributed. Upon reaching the age of majority (typically 18 to 21, but up to 25 or 30 in some states), the assets transfer to the minor, who gains full control.

Investment Choices for Minors

Within a custodial account, various investment vehicles are suitable for long-term growth, aligning with the extended time horizon available to minors. These options focus on capital appreciation and diversification, helping mitigate risk over many years.

Stocks offer potential for significant growth over long periods. While they carry inherent risk, a minor’s extended investment horizon allows more time to recover from market fluctuations. Exchange-Traded Funds (ETFs) are diversified baskets of assets that trade like individual stocks, often with lower expense ratios than other pooled investments. They provide instant diversification.

Mutual funds are professionally managed portfolios of stocks, bonds, or other securities, offering diversification. Bonds, representing loans to governments or corporations, generally offer more stability and income generation compared to stocks. They can balance a portfolio, providing a steadier return stream.

For conservative approaches or short-term goals, savings accounts and Certificates of Deposit (CDs) offer capital preservation and predictable, lower returns.

Establishing and Funding a Custodial Account

Opening a custodial account begins with selecting a financial institution that offers these account types. Brokerage firms and banks commonly provide UGMA/UTMA accounts, and many allow the application process to be completed online.

To initiate the account, specific information and documentation are required from both the custodian and the minor. The custodian needs to provide their name, address, Social Security Number (SSN) or Taxpayer Identification Number (TIN), and a government-issued identification. For the minor, their name, SSN or TIN, and date of birth are essential.

Once approved, the account can be funded through various methods, including electronic transfers, direct deposits, or mailing a check. Some institutions allow for recurring deposits. After funding, the custodian makes investment selections based on the minor’s long-term financial goals.

Tax Implications for Minor Investments

Investments in custodial accounts are subject to specific tax rules, primarily governed by the “Kiddie Tax.” This tax prevents individuals from shifting income to minors to reduce overall tax liabilities. The Kiddie Tax applies to a minor’s unearned income, including investment income like interest, dividends, and capital gains.

For the 2024 tax year, the first $1,300 of a child’s unearned income is generally tax-free. The next $1,300 is taxed at the child’s rate. Unearned income exceeding $2,600 (for 2024) is subject to the Kiddie Tax and taxed at the parent’s marginal tax rate. This threshold adjusts annually for inflation.

Reporting requirements for the Kiddie Tax involve IRS Form 8615, which must be filed with the child’s Form 1040 if the unearned income thresholds are met. If a child’s unearned income is below a certain amount (e.g., less than $13,000 for 2024), parents may elect to include the child’s income on their own tax return using IRS Form 8814.

When assets transfer to the minor upon reaching the age of majority, there is generally no immediate tax event. All future gains, losses, and income from these assets become the minor’s tax responsibility. Consulting a tax professional for personalized advice is often beneficial.