Parents who want to make smart financial decisions and teach their children to do the same often ask, "Can I open a brokerage account for my child?"
The good news is yes, you can open a brokerage account (or a mutual fund, retirement account, or education savings account) for your bundle of joy (or precocious toddler, or sullen preteen). The even better news is you'll have a few more account types to choose from than you would if you were opening one for yourself.
When you're ready to open a brokerage account for a child, the first thing to research is types of accounts.
If your child has no earned income, then put that kid to work! Just kidding. If your child doesn't get a paycheck, you can choose between two types of accounts that don't have maximum contribution limits: a guardian account and a custodial account.
In a guardian account, you own the money. You can withdraw it for any reason, and you're liable for the taxes on the earnings at your own tax rate. Practically speaking, a guardian account lets you to informally earmark funds for your child in an account in your name.
With a custodial brokerage account, you don't own the money -- your child does. As long as your child is a minor, you control the account, but any withdrawals (or dividends) can be taxed to your child, who will likely have a much lower tax rate than you. As the custodian, you can't make withdrawals except to cover certain expenses for the benefit of the child. In other words, you give up some long-term control (as well as ownership), but it's usually a better deal from a tax standpoint.
The Uniform Gift to Minors Act (UGMA) account and the Uniform Transfers to Minors Act (UTMA) account are two kinds of custodial accounts. The type your child gets depends on the state where you live. The UGMA lets your child own securities without requiring the services of an attorney or a court-appointed trustee. The UTMA expands on the UGMA and also lets minors own other assets, such as real estate, art, or patents. The UTMA account is a popular estate planning tool for transferring assets as an inheritance.
Custodial accounts are considered the child's asset. That means they can impact financial aid eligibility.
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Your 10-year-old probably isn't wondering how he'll get by on Social Security, but you might be ready to start planning for him. If he earns money, you can start saving for retirement by investing now.
One type of custodial account for a child is an IRA account. To have a regular IRA or a Roth IRA, the owner of the account must have earned income. If your kid is working (and earning income) in some capacity -- for example babysitting or mowing lawns -- then she qualifies. Allowance from parents is not considered earned income by the IRS.
You'll open the custodial IRA account or custodial Roth IRA. Junior can contribute as much as she's earned to her IRA, up to annual limits ($6,000 per year as of 2021). There's no rule that says you can't contribute the money for her. The IRS doesn't care whose bank account is used to fund the account. The only rule is that the amount can't exceed the annual limit or the actual earned income -- whichever is lower.
In addition to retirement account contributions, the IRS lets you invest up to $2,000 per year in a Coverdell.
The Coverdell education savings account is a tax-deferred investment account for a child to help pay for -- you guessed it -- educational expenses. The contribution limit is $2,000 per year, and earnings are tax-deferred. Withdrawals used for qualified education expenses before the child's 30th birthday are tax-free. And unlike a 529 College Savings Plan, a Coverdell can be used for qualified education expenses starting in kindergarten. So if you've got a bun in the oven and think an expensive private school is in his future, consider opening a Coverdell.
You must have a combined modified adjusted gross income of less than $190,000 ($95,000 for single filers) to be eligible to contribute to a Coverdell. Contribution limits phase out at higher incomes.
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The Ascent's definitive brokerage account guide covers the essentials so you can confidently take action. Get started and read our beginner's guide to brokerage accounts.
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