You want to help your child build a bright financial future. But how do you get started? While there's no one correct way to do so, a kids brokerage account can certainly play an important role for some families.
In this post, we'll take a deep dive into what exactly this type of investment account is and why it's so powerful. Plus, we'll cover the other financial tasks you might want to tackle before opening a kids brokerage account.
Let's dive in!
What is a Kids Brokerage Account?
A kids brokerage account is exactly what it sounds like. It's a brokerage account designed for children and teens. Because they are minors and cannot technically control their money until adulthood, these accounts are sometimes called custodial accounts.
What's the Difference Between a Kids Brokerage Account and a UTMA?
So how does a brokerage account compare to a UTMA? In some cases, they're the same thing! Let us explain. There are two types of investment accounts that kids can have, and it depends on one key factor: whether or not they have earned income.
Without earned income, a kids investment account will be a UTMA (or UGMA). Under the Uniform Gifts to Minors Act (or Uniform Transfers to Minors Act), you can create an account as an adult to benefit a minor. In most cases, this is a parent setting up an account for a child, though it doesn't have to be!
However, if your child has an earned income with a paper trail to prove it, then your kids brokerage account can be a custodial IRA. More than likely, you would open a custodial Roth IRA, but working with a tax pro can help you make the best choice for your family's financial situation. Then, their earned income can be set aside for their retirement. Pretty sweet to think about how your teen is actually able to set themselves up for a better retirement fifty years in the future!
It's important to note that these accounts are managed by an adult when kids are, well, kids. But when they become adults, the money is transferred to them for them to manage (or spend!) how they see fit.
Why Parents Should Consider a Kids Brokerage Account
Why would parents want to open a kids brokerage account? It's not just about building wealth, though that's certainly part of it. Another reason to open a custodial account is to help your child learn about the power of investing.
Research proves conclusively that there's no substitute for hands-on learning. I know. That means you can tell stories and jokes all you want, but the best way to make a money lesson stick is for kids to work with money themselves. That's where this kids brokerage account comes in.
You can teach kids about different investment types, as well as levels of risk. Plus, you can use a kids brokerage account to discuss the power of setting savings goals. The teachable moments that come from a kids brokerage account are limitless.
And of course, you also want to consider this type of account if you are looking for a flexible way to build wealth. Whether it's saving for specific future milestones like a wedding or a financial cushion in general, this brokerage account can help with that!
Steps to Take Before Opening a Kids Brokerage Account
Are you ready to open a kids brokerage account? Not so fast. Thinking about how much of an impact you can make on your kids' futures is so motivating. It's really easy to get caught up in the excitement. But there are actually some steps you should take before opening a kids brokerage account.
Put On Your Own Oxygen Mask
If you've flown on an airplane, you already know the drill: you put your own oxygen mask on first. It's true for airplanes, and it's also true for finances.
Before you open a kids brokerage account and start funding it with your own money, you want to make sure your finances are secure. That means making sure that you've tackled high-interest debt…or at least have a plan for it. Plus, it's a good idea to build up your own emergency fund.
Related Post: The 10 Steps to Family Wealth and Happiness
Fund Your Retirement
The next thing you want to cross off the list before opening a custodial account is your retirement. You don't actually have to fund your whole retirement, reach financial independence or achieve Coast FIRE. But you want to make sure that you have a 401k set up through work or a Roth IRA.
Your kids can take out loans for college, weddings, homes, basically anything. You cannot take out a loan for retirement.
Get College Squared Away
You don't have to have six figures set aside for college. But you do want to make sure you have a plan.
That might mean opening up a 529 to let compound interest work its magic. You might also start having conversations about scholarships and non-traditional pathways, including trade school and community college. (It's important to note that 529s can pay for those and if your child gets a scholarship, you can pull that amount out of a 529 penalty-free!)
Open a Kids Brokerage Account
After you've made sure to get a jump start on your own finances and planned for one of the first big expenses your kids will encounter in adulthood, it's time to open that custodial account. As with any type of investing, you want to pay attention to several different factors:
- Ease of use
- Transparency and fees
To simplify the process, you can look into options that your current investment brokerage offers or you can use a platform like UNest. Finding a platform that offers auto investing and has a user-friendly app can make the investing process simple and engaging.
Advantages of Kids Brokerage Account vs. 529
There's a lot to love about 529 college savings plans! But there are some drawbacks.
Within a 529 plan, the funds are earmarked for education. Most typically, they are used to cover expenses associated with college or university. The funds can also go towards certain K-12 expenses and trade schools as well. But if you use the money for a non-qualifying educational expense, you can expect to pay a 10% fee and regular income tax on the earnings portion of the account.
That's not the case with a kids brokerage account. Instead, the money can be used toward milestones, such as a first car, a wedding, a house down payment, or even education. It can also continue to grow for added financial security as your child navigates adulthood.
How a Brokerage Impacts College Admissions
Maybe you've heard that brokerages can impact college. That's true to an extent.
No one is going to turn down your kid because they have a brokerage account. But a kids brokerage account could impact the type and amount of aid they receive.
A 529 plan is considered a parent asset while a kids brokerage account is viewed as a student asset. That means that when it comes time to file the FAFSA form to see if they are eligible for any financial aid from the government, the brokerage account could actually limit their eligibility more than a 529 would.
The Power of Time and Compound Interest
To keep things simple, let's say that you make an initial deposit of $10,000 and never add another penny to your kids brokerage account. If that money compounds annually for 18 years at 8%, it will be worth almost $40,000.
But maybe they won't touch the money until they are 25. That initial $10,000 is now worth over $68,000. And what if they leave that money in the brokerage until they reach the traditional retirement age of 67? That $10,000 is actually worth more than $1.7 million thanks to compound interest.
Of course, there are plenty of other ways to fund the account. Maybe you only open it with $100 or $1000. Then, you add to it when your child is gifted money for birthdays and holidays. Perhaps when they are older, they decide to contribute money from household chores or allowance to it. No matter how you invest in a brokerage, the more time your money spends in the account, the more compound interest helps it grow.
To see the power of time in the market, spend a few minutes playing around with a compound interest calculator. Better yet, make it a family affair! If your kids are a bit older, this is the best math magic trick you can show them!
Closing Thoughts on a Kids Brokerage Account
A custodial account is a powerful way to help kids learn about managing money and investing wisely. Plus, it can set them up for a better financial future five, ten, or fifty years down the road. While this likely isn't the first item on your family finances checklist, it is certainly worth considering.
Learn more at UNest to see how a kids brokerage account might fit into your family's financial future.
Does a kids brokerage account seem like it might work for your family?
Please let us know in the comments below.