This holiday season is a great time to give your child(or grandchild, niece/nephew etc.) the gift that keeps on giving and that is the gift of stock ownership. By getting your child involved in investing at an early age this can set them up on a path of financial success for the long term. Warren Buffett started investing at the age of 11 with the money he had earned from a family business and is now one of the richest men in the world. This type of success does not happen to everyone but there are valuable lessons that can be learned from getting your child started with investing at an early age. A few of these lessons include: the value of saving, the power of compounded growth, risk and dividend reinvesting. Now I will cover how you can go about getting your child started with investing. Remember it is important to talk with a financial or tax professional about setting these accounts up.
Open a custodial account
This is the simplest way to get your child started with investing. Custodial accounts can be opened at most brokerage firms with no annual charge and they will also allow free trades of stocks, ETF’s and some mutual funds. The way a custodial account works is the adult (parent, grandparent, guardian etc.) will open the account for the benefit of the child. The money is transferred into the account and then can only be used for the benefit of the child. This money can be used towards things like a summer camp, prom dress or a first car. This account can be used to save money from birthday’s, graduation or other special events throughout the child’s life.
The custodian has control over the assets until the minor reaches the “age of majority.” Depending on which state you are in the “age of majority” is either 18 or 21. At that time the young adult will then have total control over the account and can choose to do whatever they want with the money. This is why it is very important to stress the importance of financial discipline with your child. These accounts can be great tools to teach things such as: the benefit of saving, delayed gratification, risk, dividend reinvesting and the power of compounding. This will be important to instill these disciplines early on so that later when the child is in control of the account, they do not spend the money on frivolous items.
For parents that would want more control over the assets at a later age you do have the option of setting up a trust account. A trust will allow you to put certain restrictions on what the money can be used towards, and at what age the money can be withdrawn. You can also determine what amount of money can be withdrawn at certain ages. This is a more complex option and will come with underlying costs to get this established.
Items to take into consideration:
Gift tax limits – one of the great benefits of these accounts is that they do not have an annual contribution limit. However, you do need to be aware of potential gift tax implementations. In 2020 the annual gift tax exemption amount is $15,000 per individual and $30,000 per married couple. This means that a husband and wife could contribute up to $30,000 to their child without having to pay gift tax on the money. As long as the contributions are below this amount you would not need to worry about filing a gift tax return. Any amount above those limits would then apply to the life time gift exemption and would require a gift tax return. Secondly, if the account is generating investment income of $2,100 and up in 2020 those amounts will be taxed at the estates and trusts tax rate. This is referred to as the “kiddie tax” rule.
Impact on Financial Aid – these accounts can be setup in addition to 529 college savings accounts. However, keep in mind that when completing at FAFSA form up to 20% of the child’s assets will be considered available for college expenses. Since this account is technically in the child’s name these assets will be considered.
Custodial accounts can be a great way to set your child up for success over the long term by getting them started with investing. The lessons they will learn can give them a leg up in managing their finances. Today it is even easier to get this setup for someone in your family through a free account and free trades online. If you have questions on getting this setup and what would be good investment options please reach out to me.