Personal Finance | August 20, 2021
When it comes to teaching kids about investing, a custodial brokerage account can be a great way to go. â€œGifting kids investments or cash via custodial accountsâ€”and then teaching them how to research and manage those assetsâ€”can lead to better investing habits in adulthood,â€ says Chris Kawashima, CFPÂ®, a senior research analyst at the Schwab Center for Financial Research.
Once children reach the â€œage of majorityâ€â€”typically 18 or 21, depending on the stateâ€”they gain control over the account and can use the funds however they see fit. â€œYou canâ€™t control what they ultimately do with the funds,â€ cautions Chris, â€œbut if you communicate your values along the way, your child may be more likely to follow the path you intended.â€
If this route sounds right for you, here are three things to know before opening an account:
- Gifts are irrevocable:Â Contributions to a custodial account are considered irrevocableâ€”meaning you canâ€™t get that money backâ€”and funds can be withdrawn by the custodian only to pay for expenses that would directly benefit the child before the age of majority. Note, too, that contributions that exceed the annual gift tax exclusionâ€”$15,000 for individuals, or $30,000 for married couplesâ€”may be subject to gift tax.
- Investment gains may be subject to the so-called kiddie tax:Â If any of the investments generate dividends or interest or are sold for a gain while the child is a minor, the first $1,100 of that income is exempt from tax, the next $1,100 is taxed at the childâ€™s single-filer rate, and anything beyond $2,200 is taxed at the parentsâ€™ rate.
- The funds can decrease financial aid eligibility:Â Federal financial aid formulasâ€”which determine eligibility for federal loans, grants, and even some scholarshipsâ€”consider 20% of a studentâ€™s assets, including the custodial accountâ€™s value, as available for educational purposes, whereas only 5.6% of parental assets (including 529 college savings accounts) are considered in the calculations.
Whatâ€™s more, itâ€™s important to consider your ultimate goals for the money. If youâ€™re hoping to help your child or grandchild save for college or get a head start on retirement, for example, funding a special-purpose account such as a 529 or a Roth IRA may be a better way to go.
â€œThose accounts provide unique tax advantages that a custodial account doesnâ€™t,â€ Chris says. â€œBut if youâ€™re looking to instill an enthusiasm for and appreciation of investing, custodial accounts are a great place to start.â€
Schwab MoneyWiseâ„¢: The Game offers teens 14 and older a fun, interactive way to build financial competence and confidence. Download it from the App StoreÂ®.