Help Your Child Invest Using a Custodial Account

First to get some terminology out of the way that you will need to know for this article. A custodial account is an account your child owns, but you have control over until they reach the age of 18 or 21 depending on the state you live in. This is called the age of majority. […]

First to get some terminology out of the way that you will need to know for this article. A custodial account is an account your child owns, but you have control over until they reach the age of 18 or 21 depending on the state you live in. This is called the age of majority. There is only one adult allowed per custodial account. When your child reaches the age of majority the account will become your child’s to do whatever they want with it. Hopefully, they keep it invested and believe in the process by this point, but if they decide to withdraw it all and go to Tahiti they have the freedom to do so.

Another thing to note with custodial accounts is your child will be responsible for paying tax if they sell positions with a gain or have income in the account. This will be at the child tax rate though after an exclusion. I will link the information below on this. Don’t let this stop you from investing. Remember that if your kid is paying tax, they are making money. It’s a simple form your firm will send you at the end of the year that you just plug into your tax software.

Now to get into the steps for helping your child start investing.

Step 1, Decide what account type you want to open for your child. A taxable account or a retirement account. if your child has earned income they are eligible to have a retirement account. If retirement, this will be long term money that you need to help your child understand that this money is for when they are in their 60s. If it is for retirement, then you need to open a custodial IRA and this can be Roth or Traditional. Roth is typically the best choice due to kid’s income typically being too low to benefit from a traditional IRA. More info below on this.

If this is for use prior to retirement, then earnings will be taxed along the way, but they will have access to their money at any time. You can technically access money in an ira any time, but there are rules and sometimes penalties associated.

Step 2, decide where to open the account. Two primary choices I will go over today are a traditional brokerage firm like Schwab or Fidelity, or through newer firms like Stash, Stockpile.

When the corresponding video to this article was created, the traditional brokerage firms didn’t offer fractional shares, now you can get “stock slices” in $1 increments from Fidelity or $5 increments from Schwab. This means your child can take their money and buy a portion of multiple companies instead of having to save up a lot to buy one individual stock. This will allow them the opportunity to see how different stocks work and learn more through the process. Say they buy Apple and Nike, one goes up and the other goes down. You can read an article or two with your kid and help them learn why this happened. Over time they can learn how normal price fluctuations are and develop the ability to stomach these movements. Stockpile does charge $1/trade which is really low but can add up if you buy a ton of different stocks in small increments. Try not to do that because it will just be overwhelming for your child. Fidelity and Schwab both offer their stock trading free. 

You may want to choose a traditional firm because you may already have accounts there and want to keep everything under one roof.  Another great feature that Fidelity has is they offer some index funds that have no fees associated whatsoever and no minimum to get invested. Other firms have some select funds that don’t have a transaction fee associated, so just look into your firm’s offerings and see if that works for you. With Fidelity, you could set up a recurring deposit going into a no or low fee fund and make the investing process simple. This is a good option to help your teen get started with a portfolio that they can contribute to regularly without much thought other than tucking money away for the long term. Or this is a great option if you aren’t planning to get them involved in the investing process and just want to put money aside for them.

Step 3, decide what to invest in for your child or help them decide. I suggest 80% going into a few ETFs (one large, one small, and one international), and then with the remaining 20% have them choose a few stocks to invest in. This is more for learning purposes in my opinion. Index funds are a basket of stocks, so understanding how stocks work will help us understand how index funds work. You can use the site to help you research stocks if you would like, but be careful not to get too caught up in this as it’s best to go with a company your child is familiar with and uses regularly, but it could be helpful to plug the stocks in there, just to help you understand what to expect as far as the range of highs to lows that your stock may see over a year. If you want more help on this, take a look at this video.

A nice feature with stockpile is that others can gift stock to your child online or with a physical gift card. This can be a great option when you are trying to minimize extra stuff around your house that your child may not need.

Step 4. Decide on a schedule to invest with your child. We give my daughter allowance once a month and she is responsible for budgeting that out for the month, so she will now be putting 10% of her money every month into one of the ETFs on the first of the month. Put it in your calendar and make a habit of regularly investing so it becomes a habit. This will be a nice time to review the prior month’s activity and look for any teaching opportunities. Remember to keep it really really high level with your kids because this stuff can get really confusing really fast and that last thing you want to do is to make this a time they dread vs something they look forward to. Keep your “investment meetings” short, maybe 5-10 min max.

If you want additional help, take a look at these 5 investment terms to get you started or how to buy your first stock as a beginner

 Additional resources

Custodial Roth IRA

Fidelity Zero Funds



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