Stock investment is currently accessible to everyone, regardless of whether they are fresh graduates, middle-aged, or retirement-ready. People who are at least 18 years old can legally trade stocks. So whether they choose to trade through brokers, ETFs, or CFDs. However, if a child or someone under 18 wants to trade stocks, how can they do so? How can children trade stocks? What is the custodial account? This article will give you the answer.
List of Contents
How old do you have to be to buy stocks?
In the United States, you must be 18 or older to trade stocks and other assets. (Mutual funds and exchange-traded funds (ETFs)). A legal adult, on the other hand, can set up a custodial account for a minor.
In the US, the minimum age for opening a brokerage account has nothing to do with where you live. However, in most other countries, a parent, guardian, close friend, or relative must act on behalf of a minor until the minor reaches the legal age.
Can I trade stocks for my children?
The answer is “Yes”. A parent or guardian can open a brokerage account for a child under 18. So that they can buy and sell stocks and other investments. There are different “custodial accounts”, which is good news.
What are custodial accounts?
Usually, a custodial account is a saving account that an adult keeps on behalf of a minor at a bank, mutual fund company, or brokerage firm. Account activities, like buying or selling securities, need permission from the custodian.
*A minor refers to an individual younger than 18 or 21, depending on their country of citizenship regulations.
How many types of custodial accounts are there?
Usually, there are four main types of custodial accounts, which are;
1. Custodial Brokerage Account (UGMA/UTMA)
Depending on where the minor lives, they can open a custodial brokerage account. The Uniform Gift to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA) will cover this account.
However, the child can take complete control of it when they turn legal age. Even though the adult’s name will register the account at first.
Though UGMA and UTMA accounts may have significant tax benefits. Since the child technically owns the account, investment gains are usually taxed at the child’s tax rate, which is usually lower than the parent’s rate. In particular, you don’t have to pay taxes on the first $1,050 of your income—the child’s tax rate taxes the following $1,050 earnings. When parents make more than $2,100, their tax rate goes up.
2. Custodial IRA (Traditional or Roth)
A minor child who has earned money from a parent or guardian can set up a custodial IRA or custodial Roth IRA. Once the custodial account set up, the adult takes care of the money until the child turns 18 or 21, depending on the laws in the state.
Custodial IRA
Similar to a traditional IRA, contributions are typically paid before taxes, reducing taxable income.
Custodial Roth IRA
It works the same way as a traditional: contributions are made after taxes. However, it is generally better to put money into a Roth account if the person expects to be in a higher tax bracket when the money is withdrawn. This is usually the case for minors since Roth contributions are usually better when the person withdrawing the money expects to be in a higher tax bracket.
Traditional IRAs and custodial IRAs are similar in taxes and benefits. However, a child’s contribution can’t be more than 100% of their income in any tax year. So, for example, if the kid makes $2,000 from a summer job, they can’t put more than $2,000 into the account for the whole year.
3. Coverdell Education Savings Account (ESA)
A Coverdell Education Savings Account (ESA), also called an Education IRA, is a way to save for college expenses without paying taxes on the money. An ESA can be set up for a beneficiary child under 18 by a parent or other close family member, like grandparents. Contributions can be invested in a variety of tax-deferred assets.
Withdrawals from an ESA used for qualified education expenses are also tax-free. Even though a single beneficiary can have more than one ESA, the maximum annual contribution for each beneficiary is $2,000.
4. 529 Plans
529 plans, which get their name from Section 529 of the Internal Revenue Code, are tax-advantaged ways to save for college offered by the state. As long as the money stays in the account, profits grow without tax. Withdrawals used for eligible school expenses may not be taxed by the federal government or, in some cases, by the state government.
One great thing about the 529 plan is that there are no limits on how much money can be put into it. A 529 plan account holder must be at least 18 years old and live in the U.S., just like other custodial accounts. The beneficiary of a 529 plan can be any age as long as they have a Social Security number. Another unique thing about 529 plans is that the person who owns the account and sets it up can be the same.
Even though contributions to a 529 plan are not tax-deductible at the federal level, donations to a 529 plan are sometimes tax-deductible or tax-creditable at the state level. How much of a state tax deduction you can get depends on where you live and how much you put into a 529 plan during a given tax year.
The Considerations: Before Purchasing Stocks for Children
Before purchasing stocks for your children, you need to consider what kind of account will be used to invest. Since people under 18 can’t legally open a brokerage account, a parent, relative, friend, or adult guardian must choose which custodial brokerage account, custodial IRA, or education savings account perfectly reflects their needs.
The following factors should be considered when selecting the appropriate form of investing account for children under the age of eighteen:
1. College plans
Parents might explore the Coverdell Education Savings Account and the 529 plan if attending college is a future objective. However, remember that a percentage of eligible education expenses may be spent before college enrollment.
2. Maximum contribution
There are contribution limitations on certain custodial accounts. For instance, the annual maximum Coverdell ESA contribution is $2,000. Contribution limitations for custodial IRAs are $6,000 per year or 100% of the child’s income or salary, whichever is less. However, there are no contribution restrictions for 529 plans and UGMA/UTMA accounts.
3. Holding period
Long-term time horizons are suitable for stock investing. Generally, a long-term horizon is regarded as at least 10 years.
4. Custodial IRA or Roth IRA
These IRAs require the kid to have earned earnings or income during the contributing year. Custodial Roth IRAs are often suitable for children. It means that their tax rate at the time of contribution is lower than it would be at the time of withdrawal.
5. Tax benefits
School savings accounts (ESAs) provide significant tax advantages to minors using the funds for qualified education costs. (such as the Coverdell ESA and the 529 plans) Both kinds increase tax-free. Traditional IRA contributions are tax-deductible, and withdrawals are taxable. On the other hand, Roth IRA contributions are made after taxes, and withdrawals are tax-free. Earnings on assets kept in UGMA and UTMA brokerage accounts are subject to taxation at the child’s marginal income tax rate.
In conclusion, everyone can trade stocks for their own needs. However, since it is against the law for children under 18 to open a brokerage account in the US, they can’t buy stocks without the help of an adult. However, an adult can open a savings account for a minor so that they can invest on their behalf. Accounts for children include custodial brokerage accounts, custodial IRAs, Coverdell ESAs, and 529 plans.
FAQs
A custodial account is a type of savings or investment account that is opened and managed by an adult on behalf of a minor.
The money in a custodial account is legally owned by the minor, but it is managed by the adult custodian until the minor reaches the age of majority.
The age of majority for a custodial account varies by state, but it is typically 18 or 21.
A custodial Roth IRA for kids can help turbocharge a child’s retirement by providing tax-free growth and withdrawals in retirement.
Custodial accounts can serve as an opportunity for custodians to teach children the value of investing and building wealth from a young age.
Related Articles:
- The Fallen Kingdoms of the “Technology Stock” Era
- Investing in Metaverse: Another Interesting Way to Invest in 2022
- How Old Do You Have to Be to Get Your First Official Credit Card?
Read more: Stocks
Source: Seeking Alpha