Investing for Kids: Complete Guide

Do you want to give your kids a financial safety net but don’t know where to start? 💰

Whether you’re putting spare cash in a bank account or starting a college fund for your kids, all good parents want to give their kids a headstart on the rat race we call life. But with the inflation rates going up every year, you know that simply squirreling money away won’t give your kids a net gain in the future. 

Besides, presenting your kids with a cushy nest egg is only half the battle—the world can be a dangerous place for all who are not financially savvy. As the saying goes, ‘teach a man to fish, and they eat for life’—the end goal is to give your kids a means to grow and manage their wealth wisely even after you’re long gone.  

In this article, we’ll cover some of the standard investment accounts that you can start with your kid, including different types of IRA accounts and funds for specific purposes. We’ll also explore the basic investment instruments your kids can use to make an optimized portfolio that’ll pay dividends for years. 

What you’ll learn

• How to Invest for Your Kids
• Types of Investment Accounts for Kids
• Savings Accounts for Kids
• Best Investments for Your Kids
• Choosing the Best Broker for Your Kids
• Is Investing for Your Kids Worth It?
• Conclusion
• FAQs

How to Invest for Your Kids 🔎

Time is your biggest asset when it comes to investing, and who else has more time on their side than children and teenagers? There’s no such thing as starting too early—even small deposits can lead to massive gains later down the road. 

Unfortunately, minors don’t have the right to form contracts in the U.S.—if they’re not old enough to vote, they can’t have their own investment account. Not only that, but some of the most popular brokerage apps require your kids to be at least 18 years old—or 21 in some states—before they can set up an account. 

The only way to invest on behalf of your kids is to set up a custodial account under your kids’ names and manage it for them until they become an adult. It acts the same way as any investment account—the account holder deposits money into the account and invests accordingly. 

Types of Investment Accounts for Kids 📈

Although your kids can’t open their own investment accounts, there are plenty of investment options that you can choose for them. In this section, we’ll detail the types of plans available for different financial goals and purposes. 

UGMA/ UTMA Accounts 👥

If your kids don’t earn any income or are simply too young, a UGMA or UTMA account is probably the best type of investment account for them. Short for the Uniform Gift to Minors Act, a UGMA account allows you to transfer assets like cash, inheritance, and securities to minors. The Uniform Transfer to Minors Act (UTMA) expands the transferable assets to include real estate and fine art. Not every state provides both types of accounts, so don’t spend too much time mulling over what’s best. 

With a UGMA or UTMA account, the money you contribute will grow with your children instead of accumulating meager interests and losing value to inflation in a savings account. Not only that, but it’s much easier to dip into the account for any child-related expenses that you might have as there isn’t any early withdrawal penalty. 

Since all assets in these accounts technically belong to your children, you don’t have to pay taxes on their investment returns. However, these accounts are subject to the child gift tax, which means your children must file taxes if the assets exceed a certain amount. 

All custodial investment accounts have to be turned over to your children as soon as they reach the age of majority. Your child could use the money to start a new chapter of their lives, but you’d have no control of the money if they decide to invest in an MLM scheme instead. Besides that, they might not get financial aid or a scholarship to their school of choice since they technically own a large sum of money in the investment account. 

Kiddie Tax 💸

Although UGMA/UTMA accounts are tax-advantageous, they are not entirely sheltered from Uncle Sam. The Kiddie Tax was introduced in 1986 to prevent parents from exploiting tax loopholes by transferring many assets to their children. It applies to the unearned income of any child under 18 or full-time students below 23 years old. 

For example, if your kid has $5,000 (including dividends and investment returns) in their account inheritance at the end of the 2021 tax year, the first $1,100 would be tax-free. That means the total taxable amount comes down to $3,900, $1,100 of which is taxed at your child’s rate, which could be as low as zero percent. The remaining $2,800 would be taxed at your rate. 

Roth IRA for Kids 👶

Chances are your older kids would get summer jobs or even start a small home business to fund the luxuries that you’ve denied them. So why not encourage them to build their wealth by teaching them to invest in their future? 

Since your kids are unlikely to make too much money mowing grass or babysitting, a Roth IRA for Kids account is preferred over investing in traditional, upfront tax-heavy IRA accounts. Here, you can match your kids’ earnings and have it grow tax-free until they withdraw it in the future.  

Investing for Retirement at 7% Annual Interest: Why the Investor’s Starting Age is Important

Let’s say your child earns $1,500 from their side hustle every year, and you match their income. Including your contribution, your child would be putting in $3,000 into their Roth IRA account. When consistent contributions and the annual 7% growth are considered, they will have become a millionaire by the time they retire! 🤑

That said, your kids won’t have to wait until retirement to see the fruits of their labor. As the account owner, your kids can withdraw 100% of their contributions at any time. However, they can only take out the earnings from their Roth IRA account when they turn 59 and a half or due to disability and death.

With strategic planning, your kids can use the funds to pay for their college tuition and future endeavors like starting a business. After five years of contribution to the Roth IRA account, they can also withdraw up to $10,000 for the downpayment of their first home. 

But don’t dip into your kids’ Roth IRA accounts too eagerly—nothing beats having small investments grow into a life-changing sum of money. Besides that, the IRS limits contributions from individuals below 50 to a certain amount every year. In 2021, the total contributions cannot exceed $6,000, or $7,000 if you’re older than 50.

529 College Plans 🎓

If your kids are aspiring academics, you can use a 529 college plan to fund their education. This unique investment account offers tax benefits when you use it to pay for your kids’ current and future schooling costs. Now, there are over 100 different 529 plans available for various education savings needs.

Although it’s exclusively used for college in the past, the tax reforms in 2018 expanded the scope to include any expenses, like K-12 tuition, apprenticeship programs, and student loan repayments. With this plan, not only can you pay for your kid’s education, but you’re also limiting your tax liability when you liquidate the investments in the account. Like Roth accounts, the money you put into 529 plans grows tax-free from federal income tax. 

Besides that, 529 college plans offer high limits that you or your kids’ grandparents can contribute without incurring a gift tax—$15,000 per person or $30,000 for married couples who file jointly in 2021. You can contribute more than that, but any excess will count towards your $11.7 million limits (with your partner) on lifetime gift tax. 

The primary downfall of a 529 plan is that you incur a 10% withdrawal penalty or lose your tax benefits if you withdraw the money without using it for your child’s educational purposes. For this reason, you have to make sure that your kids are planning to go to college or take on apprenticeships before investing in a 529 plan. 

Savings Accounts for Kids 💰

Back in the day before super-low interest rates, some high-yield savings accounts in the U.S. had handsome returns that far outpaced inflation. But, with a variety of investment apps like Acorns specializing in serving early investors, it doesn’t make much sense to just put money in a savings account and hope for the best. 🔮

But that doesn’t mean that savings accounts don’t have a place in your kids’ lives. For one, your kids can learn how interests and banking work with youth savings accounts. Many savings accounts also come with debit cards that you can monitor and set guardrails to teach your kids how to handle their allowance or pay.

If nothing else, a youth savings account is a great place to store emergency funds since many investment accounts don’t offer the same amount of flexibility when it comes to early withdrawals. This way, you’d have money for a rainy day while your kids’ cash grows steadily in an investment account. ⛈️

When choosing a youth savings account, you’d want to pay close attention to the minimum balance requirement, interest rates, and minimum age. 

Best Investments for Your Kids 🏅

While it’s highly improbable for your kids to lose all their money before they grow up, you should still be wary when investing in the market for them. The most important lesson to keep in mind is your long-term arc. You have plenty of time to see the fruits of your labor and going all-in on hot tips is never a good idea. 

Since your kids potentially have decades to grow their wealth, it makes the most sense to invest in long-term passive assets like bonds and gold, as they are usually very safe to invest in. As it is with your portfolio, you should also make sure that your kid’s portfolio contains a diverse set of securities strong enough to weather any financial storm that might happen within the next twenty years. 

Stocks for Children Explained 💵

There are always dangers in the stock market, but the risk is severely minimized for your kids’ portfolio. That’s because individual stocks perform the best over a longer period—the type of time that your kids have. So even though your mini-me might prefer a PS5, gifting them some stocks would provide more value long term. 

Under custodial accounts, your kids can hold various individual stocks, ETFs, or mutual funds. One way to encourage your kids to invest is to buy stocks of household names that they’re familiar with, like Meta (formerly known as Facebook), McDonald’s, and The Walt Disney Company. 

Exchange-Traded Funds (ETFs) 📊

Like mutual funds, an ETF is an investment vehicle designed to group and track a variety of securities on the stock exchange. They are generally regarded as a safer purchase since it’s unlikely that all the stakes in the fund would perform poorly at once. ETFs also provide more liquidity than mutual funds since they actively trade throughout the day.  

EFTs come in different shapes and sizes, so you’re bound to find something regardless of your investment style and financial goals. Equity, commodity, and real estate funds are among the more popular funds, but you can also choose EFTs that track foreign markets or industries if this floats your boat. Regardless, one of the biggest perks for buying ETFs is that you don’t have to meticulously study securities to diversify your portfolio—they are already diversified!  

As an investor, you buy a portion of the assets they track, which entitles you to ETF dividends. Depending on your financial goals, you can choose to reinvest your dividends (long-term gains) or cash out. Some companies require you to reinvest your dividends to grow the business, so avoid these if you’re looking for quick returns. 

You should also consider how you want your funds to be managed when buying ETFs. Passive ETFs (also known as index EFTs) are left to grow by themselves, so you’d save on management fees and even trading commissions if you use a free stock trading app. Active ETFs tend to net you higher profits at the cost of a higher management fee. 

But that doesn’t mean you should stick to index ETFs to save cost, though. You can use the expense ratio to figure out if it’s worth buying an active ETF. As a general rule of thumb, any expense ratio that falls within 0.5% to 0.75% is considered reasonable, like Ark Innovation ETF (AARK, 0.75%) and SPDR DoubleLine Total Return Tactical ETF (TOTL, 0.55%). Passive EFTs, however, generally fall around 0.2%. 

Benefits of Bonds for Kids 🏛️

Bonds are generally considered a much safer investment than stocks since the return is generally fixed. Although it gives you an idea of how much you’ll get when it matures, there is a lower potential for increased returns. 

A major plus point for savings bonds is that they are the only thing that kids can own without a custodial account—You can even gift the bonds to your children on Christmas day if you want to. 🎅 

And by the time your child turns 18, they can sell the bonds for their face value and any interest it’s accrued.  

Gifting Gold (as an Investment) for Children 🥇

Gold has historically been seen as a precious commodity, which is a fact that hasn’t changed one bit. In fact, gold prices tend to spike when the U.S. dollar is weak, making it a unique and strong security as it protects against both inflation and deflation. Besides that, it’s also a globally-recognized asset that could help your children in the off-chance of geopolitical uncertainty in the future. 

You can gift gold to your children in both physical and digital gold. Digital gold has become increasingly popular among millennials and Gen Z investors since it offers the benefits of traditional gold without the hassle of storage or liquidation. You can also purchase gold ETFs for your kids. 

Choosing the Best Broker for Your Kids 🏆

A few factors come into play when you’re investing on behalf of your children with a broker. Ideally, you should opt for brokers with low or no trade commissions. Your kids would inevitably make mistakes when they’re trading, so even saving a few cents of commissions will add up in the long run. 

A well-diversified portfolio is the best portfolio, so you should also opt for a broker with a large selection of investment instruments like EFTs, bonds, and stocks. This gives you the option to manage your child’s portfolio based on their financial goals as they grow up. If your goal is to establish a passive income stream that passes the test of time, you can also opt for low-cost index funds. 

Fees

Minimum initial deposit

$0 to open account

$0

Account minimum

$5 required to start investing

Starts at $3*

Commissions

$3 or $5/month

$0

General

Best for

People who struggle to save

New investors

Promotion

$5 bonus¹

Highlight

“Invest spare change” feature

Value-based investing

Rating

7.0/10 Visit Acorns on Acorns' website

8.0/10 Visit Stash on Stash's website

Fees

Minimum initial deposit

$0

$0

Account minimum

Starts at $3*

$0

Commissions

$0

Vary

General

Best for

New investors

Active traders

Promotion

$5 bonus¹

Highlight

Value-based investing

Huge discounts for high-volume trading

Rating

8.0/10 Visit Stash on Stash's website

8.0/10 Visit Interactive Brokers on Interactive Brokers' website

Fees

Minimum initial deposit

$0 to open account

$0

$0

Account minimum

$5 required to start investing

Starts at $3*

$0

Commissions

$3 or $5/month

$0

Vary

General

Best for

People who struggle to save

New investors

Active traders

Promotion

$5 bonus¹

Highlight

“Invest spare change” feature

Value-based investing

Huge discounts for high-volume trading

Rating

7.0/10 Visit Acorns on Acorns' website

8.0/10 Visit Stash on Stash's website

8.0/10 Visit Interactive Brokers on Interactive Brokers' website

Is Investing for Your Kids Worth It? 🤔

Definitely! Think about it—you’re already investing in your kids by giving them a good education, buying them everything they need for their hobbies, and watching them excel in their curricular activities. So why would investing on behalf of your kids be any different?  

One of the biggest reasons to invest for your kids is that they have years to wait for their portfolio to grow. Even putting a modest sum each month into a safe portfolio can amount to a lot over a long period. 

Here’s an example. If you invest $200 in your kid’s portfolio each month since their birth and expect the average stock market yield of around 10% per year, you’ll be looking at almost $150k by the time your kids are 20 years old. That’s their college education paid for! 

But it doesn’t stop there. If your kids inherited your stock market wisdom and kept the portfolio up for another decade, they’ll be looking at about $420k in their assets and accounts. If you increase those monthly deposits to $500 per month, your kids will end up with over a million in three decades! 

Investing in a Portfolio with a 10% ROI

Besides that, watching you grow their portfolio might also inspire them to be better savers and more conscious spenders. In a world filled with material temptations, being financially savvy is one of the most important life skills to have. 

Conclusion 🏁

In a nutshell, there’s really no reason not to invest for your kids if you’re already putting money away in a bank account for them. Like a savings account, even small deposits can lead to a literal pot of gold in the future—the difference is that they get substantially more when they’re ready to be independent. Not only that, but you’re also teaching them essential investment and financial skills they need to thrive in the future. 

Although you won’t know for sure what your kid wants to be when they grow up, you can choose from a wide range of plans and custodial accounts to cater to their future financial needs. But one thing’s for sure—investing for your children is the way to give them the best headstart you can.  

About the author

Tim Fries

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Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird's US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.