Investing for Kids: Complete Guide

Account Types for Investing for Kids

There are several ways to invest for a child, each with different tax implications, control structures, and flexibility. The right choice depends on your goals: Is this for college? General wealth building? Teaching financial literacy? Let's break down each option.

UTMA and UGMA Accounts: The Basics

UTMA (Uniform Transfers to Minors Act) and UGMA (Uniform Gifts to Minors Act) accounts are custodial accounts that allow adults to hold assets on behalf of minors. The money belongs to the child, but an adult custodian manages it until the child reaches adulthood (typically 18 or 21, depending on the state).

How UTMA/UGMA Works

You open the account at a brokerage in your name "as custodian for" your child. You manage all investment decisions until the child reaches the age of majority. At that point, the account transfers fully to the child—they get complete control of the money, no strings attached.

The key distinction between UTMA and UGMA: UGMA accounts can only hold financial assets (stocks, bonds, mutual funds, cash). UTMA accounts can hold those plus real estate, art, patents, and other non-financial assets. For most people investing through a brokerage, this distinction doesn't matter because you're buying financial assets anyway.

Tax Treatment of Custodial Accounts

Custodial account earnings are taxed at the child's rate, with special "kiddie tax" rules:

• First $1,300 of unearned income: Tax-free (2025)
• Next $1,300: Taxed at child's rate (usually 10%)
• Above $2,600: Taxed at parents' marginal rate

The kiddie tax applies until the child turns 19 (or 24 if a full-time student). After that, all income is taxed at the child's own rate, which is often very low if they're a young adult without much income.

This creates a planning opportunity: keep custodial account earnings under $2,600/year to avoid the higher parental tax rate, then let the account grow more aggressively after the child exits kiddie tax territory.

The Control Issue: The Biggest Drawback

Here's what stops many parents: when your child reaches the age of majority (18 in most states, 21 in some), the money becomes 100% theirs. They can spend it on college, a car, a business—or blow it all on something you'd never approve of. You have zero legal recourse.

This is a feature, not a bug, from a legal perspective. The money was always the child's property; you were just managing it for them. But it gives many parents pause, especially with large sums.

Some strategies to mitigate this: keep custodial account balances moderate, use 529 plans for larger education savings (more control), or have honest conversations with your child about money as they approach adulthood. Some parents intentionally keep custodial accounts smaller and use them as teaching tools rather than primary savings vehicles.

529 College Savings Plans

529 plans are tax-advantaged accounts specifically designed for education expenses. Unlike custodial accounts, you retain control of the money throughout—the child is the beneficiary but never controls the account.

Tax Advantages of 529 Plans

The tax benefits are substantial:

• Tax-free growth: Investments grow without annual taxation
• Tax-free withdrawals: For qualified education expenses (tuition, room and board, books, computers, K-12 tuition up to $10,000/year)
• State tax deductions: Many states offer deductions or credits for 529 contributions (check your state's rules)
• Gift tax benefits: Contributions count as gifts but you can "superfund" 5 years of gifts at once ($90,000 single / $180,000 married in 2025)

529 to Roth IRA Rollover (New in 2024)

Starting in 2024, a major new benefit allows unused 529 funds to roll over into a Roth IRA for the beneficiary. Requirements:

• 529 must have been open for at least 15 years
• Maximum lifetime rollover: $35,000
• Annual rollovers limited to IRA contribution limits ($7,000 in 2025)
• Contributions made in the last 5 years can't be rolled over

This addresses the biggest 529 concern: "What if my kid doesn't go to college or gets scholarships?" Now there's a penalty-free escape route into a Roth IRA.

529 Downsides

The education restriction is significant. If funds are withdrawn for non-education purposes, you'll owe income tax on earnings plus a 10% penalty. Investment options are also limited to whatever the 529 plan offers—you can't buy individual stocks or any fund you want like in a brokerage account.

Additionally, 529 assets can impact financial aid. They're counted as parental assets (up to 5.64% counts against aid), which is better than if they were the student's assets (20% counted), but not as favorable as retirement accounts (not counted at all).

Custodial Roth IRA

If your child has earned income (from a job, babysitting, their own business, etc.), they're eligible for a Roth IRA. A custodial Roth IRA is managed by a parent until the child reaches adulthood, but it's owned by the child.

Why Custodial Roth IRAs Are Powerful

The math is incredible. A child who contributes to a Roth IRA from ages 14-18 and never contributes again can end up with more than someone who starts at 25 and contributes for 40 years. Time is that powerful.

Consider: $6,500 contributed at age 15, left for 50 years at 7% annual return, grows to over $190,000—tax-free. If your child earns $6,500/year from ages 14-18 and maxes out a Roth each year, that $32,500 could become nearly $1 million by retirement age, all tax-free.

The Earned Income Requirement

The child must have earned income (W-2 wages or self-employment income) equal to or greater than the contribution. If your 14-year-old earns $3,000 babysitting, they can contribute up to $3,000 to a Roth IRA.

Some parents employ their children in a family business specifically to create earned income for Roth contributions. This is legitimate if the child does real work and is paid a reasonable wage. The IRS does scrutinize these arrangements, so keep documentation.

Custodial Roth Considerations

Unlike custodial brokerage accounts, Roth IRA assets are generally protected from financial aid calculations. And while the child gains control at adulthood, the retirement account structure provides some psychological barrier to casual spending—it's clearly marked as retirement money.

Not all brokers offer custodial Roth IRAs. Fidelity, Schwab, and Vanguard do. Check before opening an account.

Comparing Your Options

Which Account Should You Choose?

Choose UTMA/UGMA If:

• You want maximum flexibility for how the money is used
• You want to teach investing with a real account
• You're comfortable with the child taking control at 18/21
• You want to invest in specific stocks or any fund
• The amounts are moderate (not your primary education savings)

Choose 529 If:

• College savings is the primary goal
• You want to retain control regardless of child's age
• You want tax-free growth and withdrawals for education
• Your state offers tax deductions for contributions
• You're saving large amounts for education

Choose Custodial Roth IRA If:

• Your child has earned income
• You want tax-free retirement savings with massive time horizon
• You want to minimize financial aid impact
• You're teaching the value of retirement savings early

The Combination Approach

Many families use multiple accounts: a 529 for dedicated college savings (benefiting from tax-free education withdrawals), a small UTMA for teaching investing and general flexibility, and a custodial Roth once the child has earned income. This provides tax efficiency, flexibility, and financial education.

Best Brokers for Custodial Accounts

Fidelity

Offers UTMA/UGMA, custodial Roth IRAs, and the Fidelity Youth Account (for teens 13-17 to manage their own investing under parental supervision). Excellent educational resources and no account minimums. The Youth Account is unique—it lets teens trade with their own app while parents maintain oversight.

Schwab

Full range of custodial accounts with strong customer service and branch access if you prefer in-person help. Good educational resources and no minimums for custodial accounts.

Vanguard

Great for index fund investors. UTMA/UGMA and custodial IRA options available. Interface is dated but improving. Lowest-cost index funds available.

M1 Finance

Offers custodial accounts with automated investing through "pies" (portfolios). Good for hands-off, automatic contributions. Modern interface appeals to younger investors.

What to Invest In

For children with decades until they need the money, aggressive growth allocations make sense:

• Total stock market ETF (VTI): Broad US exposure, ultra-low cost
• S&P 500 ETF (VOO): Large-cap US stocks
• Growth ETF (VUG): Growth-oriented companies
• International (VXUS): Diversification beyond US

For younger children, 100% stocks is reasonable given the multi-decade time horizon. As they approach 18 (when they might need the money for college or other purposes), consider shifting toward a more balanced allocation.

Avoid the temptation to pick "fun" stocks for kids just because they recognize the brand. A total market index fund will almost certainly outperform a portfolio of Disney, Nike, and McDonald's over 18 years.

Teaching Kids About Investing

The greatest gift of a custodial account may not be the money—it's the financial education opportunity.

• Show them statements: Review account performance quarterly
• Explain compound growth: Use calculators to show future projections
• Discuss volatility: When markets drop, it's a teaching moment about long-term thinking
• Let them pick (small amounts): Perhaps 10% in stocks they choose, 90% in index funds
• Match contributions: Encourage saving by matching what they contribute from allowance or jobs

Fidelity's Youth Account specifically facilitates this by giving teenagers their own app to manage investments (with parental oversight). It's a powerful tool for financial education.

The Bottom Line

Starting investing for your child early is one of the most impactful financial gifts you can give. The account type matters, but starting matters more. A simple UTMA with automatic monthly contributions into a total market index fund will serve most families well.

For families with specific goals (college savings, teaching financial responsibility, maximizing tax efficiency), combining 529 plans, custodial accounts, and eventually custodial Roth IRAs creates a comprehensive approach.

The most important thing: start. Even $50/month from birth, invested in a simple index fund, can grow to meaningful wealth by the time your child reaches adulthood. Time is the one investment factor you can control—don't waste it.