It pays to start investing early. Even if your kid isn’t yet old enough to count, let alone make savvy financial decisions, you can give them a head start by investing for them now. Many online brokers offer custodial accounts designed to allow a parent to make investments in their child’s name. When your kid reaches the age of majority, the account—and all the funds you’ve saved for them—becomes fully theirs.
Here’s what to know about getting started investing for your kids as early as possible using a custodial brokerage account, and whether or not it’s the right move for you.
What is a custodial brokerage account?
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There are several types of accounts you can open to start investing for your child while they’re still young. Two of the most common are 529 education savings plan and custodial Roth IRAs, but let’s consider a lesser-known option: a custodial brokerage account.
Many custodial accounts are Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) accounts. These work like regular taxable brokerage accounts, but since they’re custodial, your child doesn’t control the account until they reach the age of majority in your state. Until then, the custodian—that’s you, and even other family members—can make contributions and invest that money into stocks, bonds, or mutual funds to grow the account balance.
Most major brokers, like TD Ameritrade, Fidelity, Merrill Edge, and Vanguard, offer custodial accounts. Beyond the banks, there are also third-party apps designed to help parents open and manage custodial investment accounts for their kids, though those come with caveats we’ll discuss in a moment. (Fun fact: According to Union Bank, 401(k) plans are technically custodial accounts, since the employer acts as custodian for the employee. Yes, this fact was fun. You loved it.)
The pros and cons of custodial brokerage accounts
The main reason to open a UTMA is to take advantage of the gift tax exclusion to grow your investments for you child, while providing greater control over how the money is invested and, later, spent. The main drawback is that they offer fewer tax benefits compared to a Roth IRA or a 529 plan.
Unlike 529 plans, custodial accounts are subject to a “kiddie tax” on unearned income up to a certain threshold. For 2023, any unearned income (that is, investment income) over $2,500 is taxed at the parents’ tax rate. And once money goes into a custodial account, it can’t be taken back.
However, with a UTMA, once your child is old enough, they can use the funds in their account for any expense—whether that’s paying for college or buying a car. That’s in contrast to a 529 plan, which requires the funds be used to pay for their education. This means if you know you’re only investing for your child’s future education, a 529 plan will offer greater tax-deferred growth. But if you’re aiming to supplement a 529 and want more wiggle room with how your kid’s funds can eventually be spent, a UTMA provides more flexibility.
(It’s also worth keeping in mind that a UTMA may affect your child’s financial aid eligibility down the line. Read more about that here.)
How to open a custodial brokerage account
Parents, grandparents, and guardians can open a custodial account at virtually any brokerage or financial institution. These financial institutions set the terms of the accounts, including initial investment requirements, minimum account balances, interest rates, and management fees. Usually, these terms are similar to those that any of the firm’s standard accounts.
The minimum balance to open UTMA generally ranges from $500 to $2,000. Anyone can contribute to the custodial account, but because of gift-tax laws, many cap contributions at $15,000 ($30,000 for married couples) per child, per year.
Beware of pricey third-party apps
One rule to keep in mind when opening a custodial account for your children: Don’t get duped into paying unnecessary fees. You have the option to go through a service like UNest to get started with your custodial brokerage account—and if you’re an unseasoned investor, a pre-built portfolios can be a good way to get rolling.
However, these app’s service fees may not be worth the guidance they offer. For instance, Investor Junkie breaks down just how much you’d be paying UNest to manage your funds:
“..if you stick with the lowest $25 monthly contribution, you contribute $300 to your child’s custodial account in one year. But with the $2.99 monthly fee, you’re paying 11.96% for UNest to invest your money.”
Compared to commission-free trading at most major institutions, UNest is charging an absurdly high fee that will only be worth it for a larger account balance. Before you assume you need the help of an investment app, look into getting guidance from your primary online broker.