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It’s never too early for children to start learning about money. And the earlier they build their financial literacy, the better equipped they’ll be to navigate their finances later in life. Set your little ones up with a kid’s investment account in three simple steps.
Kids can’t open an investment account on their own. That’s where you come in. The type of account you’ll need is called a custodial account. And custodial accounts come in three distinct flavors: UGMA and UTMA accounts are designed for kids without taxable income, while custodial IRAs are for older children earning money from a part-time job.
Uniform Gifts to Minors Act (UGMA) accounts allow you to invest in stocks, bonds, mutual funds and insurance policies on behalf of your little one. Whatever the value of the account, it belongs to your child. When they reach the age of majority in their state — typically between the ages of 18 to 21 — they take control of the account.
The first $1,050 deposited into a UGMA or UTMA account is tax-free, the second $1,050 is taxed at the child’s tax rate, and anything beyond this is taxed at the parent’s rate. Another perk? UGMA and UTMA accounts have no contribution limits.
Uniform Transfers to Minors Act (UTMA) accounts are similar to UGMA accounts — except they let you invest in a wider range of assets, including real estate. UTMA accounts may also have a later termination date: UGMA account funds are typically distributed when the child turns 18, while UTMA accounts may terminate as late as 25.
Babysitting, dog walking, yard work for neighbors — it all counts as income. For older kids earning money, you’ll want to consider a custodial IRA or individual retirement account.
“But it’s too early to worry about retirement,” you say. “My kid’s only 15!” Well, it’s never too early to plan for retirement. And you have the opportunity to give your child a serious leg up on the future with a custodial IRA.
Imagine you put $50 monthly into a custodial account. In 30 years, you’d have contributed $18,000, but your child would have over $50,000 — based on a 6% annual growth rate with interest compounded monthly.
What’s more, is that custodial IRAs are tax-advantaged. And there are two options available:
Now, here’s the rub: Since most kids don’t earn enough to owe income tax, a traditional IRA’s tax-free contribution won’t be overly beneficial. At least not when it comes to depositing all that babysitting money. But this is precisely why a Roth IRA is so advantageous for kids and teens — you’re essentially getting tax-free contributions and distributions if you go the Roth route.
Like UGMA and UTMA accounts, custodial IRAs transfer to your child once they reach the age of majority in your state.
Once you’ve settled on an account, it’s time to select a broker. Narrow down your platform options by those that offer custodial accounts. Then consider the following:
Once you’ve settled on a broker, here’s a quick look at the account-opening process:
Perhaps the most exciting step in this process is picking your investments. And it’s here that you have the opportunity to get your kid in on the action.
What kid would turn down the opportunity to own a little slice of Disney or McDonald’s? The good news is that most of the companies children are familiar with are well-established blue-chip stocks and are considered relatively low-risk investments.
Here are just a few ideas to get you started:
While not quite as glamorous as stocks, exchange-traded funds offer the opportunity for diversified, long-term growth. Kid-friendly translation? They spread your money across different types of companies so you’re less likely to lose money in the long run.
As far as ETFs are concerned, some are more exciting than others. And industry or niche-specific ETFs give you the opportunity to chat about what types of businesses your child is interested in.
A few conversation starters might include:
Bonds are perhaps the least-exciting on this list, but they’re one of the safest investments for kids. And that’s because bonds are a steady, fixed-income investment capable of providing consistent returns.
The two main types of bonds to consider are government and corporate bonds. Government bonds are typically the safer investment, but no bond is foolproof.
When in doubt, look to a bond’s credit rating. A strong credit rating of BBB-/Baa3 or higher suggests the issuer is in a strong financial position.
It’s never too early to teach your kids about money management or how to save for the future. Compare investment accounts to find the right option to grow your family’s hard-earned cash.
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