In this grand age of communication and technology, it is likely your teenager is on the internet and has come across the concept of investing. Perhaps their curiosity was sparked by reading the forum WallStreetBets on Reddit, seeing a Tweet about stocks, or a family member sharing an article on Facebook about saving for retirement.
If they are ready to start investing, the good news is they have options! Many custodians and platforms allow minors to open a retirement or taxable investment account with parental consent. This provides a great opportunity for teenagers to learn how to save and invest, all while gaining valuable financial literacy. In addition, the younger someone is when they begin investing, the more time their investments have to grow through compound earnings. It’s a win-win!
- Retirement Accounts
A Traditional IRA or Roth IRA are appropriate choices for minors who want to start saving and investing for their retirement. Both Traditional and Roth IRAs grow tax-free, but a Roth is usually recommended for young people due to a couple of features. A Roth IRA is funded with after-tax dollars, so the contributions and earnings grow tax free. This means that when your child starts making withdrawals later in life, when they will likely be in a higher tax bracket, the distributions will not be taxed. A Traditional IRA is also an option, but taxes must be paid when funds are distributed out of the account during retirement, which is why there are Required Minimum Distributions.
To open an IRA for your teenager, they must have earned income from working and you will need to be the custodian of the account. The account will be opened in your child’s name, but you will be responsible for the account until they reach the “age of majority” at 18 or 21 years old (depending on your state), at which point it will be transitioned to their sole ownership. It is important to ensure your child understands that an account of this type ideally will not be touched until retirement because there can be tax penalties for early withdrawals.There are a few exceptions for qualified distributions, including educational expenses and a first home purchase, though limits apply.
- UGMA and UTMA
Uniform Gifts To Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts may be the best choice if your child doesn’t have any taxable income or wages yet, but you would like to start investing for their future. The difference between UGMA and UTMA accounts is that an UGMA can only hold financial instruments, like cash, stocks, and bonds. An UTMA can hold any kind of property, including cars and real estate. UGMA accounts are available in all states, but UTMA accounts are not.
Both accounts function essentially as a trust, without requiring the preparation of legal documents, and are intended to hold assets for a child until they reach the age of majority.These accounts are unique from a trust because there cannot be any conditions set nor limitations on how the funds are spent once the account transfers to the beneficiary.
Contributions of money or other property are irrevocable, meaning they become property of the minor beneficiary and can only be withdrawn for their benefit or by them once they are old enough. It is important to keep in mind that the earnings in these accounts are taxable, so they may need to be reported on a tax return, and, since the accounts are your child’s assets, they could affect financial aid for college.
- Next Steps
With this information in mind, you may want to reach out to a trusted professional such as a CERTIFIED FINANCIAL PLANNER™ or Certified Public Accountant for further questions. It is important to consider your child’s financial needs and interests, as well as the requirements and tax considerations of each account type. Help your teen understand that investing is a long-term activity and that it can be an emotional experience to see market fluctuations affect accounts balances and positions. With guidance, investing can be a great tool for minors to learn about money management, financial risk, and taxes.