How a Custodial Brokerage Account Can Help You Invest in Your Children’s Future Now

It’s worth starting to invest early . Even if your child is not yet old enough to count, let alone make smart financial decisions, you can give him an edge by investing for him now. Many online brokers offer custodial accounts designed for a parent to invest on behalf of their child. When your child reaches the age of majority, the account and any funds you have set aside for them are transferred to them in full. Here’s what you need to know about how to start investing for your kids as early as possible using a depository brokerage account and if it’s right for you.

What is a custodial brokerage account?

There are several types of accounts you can open to start investing for your child while they are young. The two most common are the 529 Education Savings Plan and Roth Custodial IRAs, but let’s take a look at a lesser known option: a custodial brokerage account.

Many custodial accounts are Uniform Gifts to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) accounts. They operate like regular taxable brokerage accounts , but because they are custodial, your child cannot control the account until they reach the age of majority in your state. Until then, the custodian—that is, you and even other family members—can contribute and invest that money in stocks, bonds, or mutual funds to increase your account balance.

Most major brokers such as TD Ameritrade, Fidelity, Merrill Edge and Vanguard offer custody accounts. In addition to banks, there are also third-party apps designed to help parents open and manage depository investment accounts for their children, although they come with some caveats that we’ll discuss in a moment. (Fun fact: According to Union Bank , 401(k) plans are technically deposit accounts because the employer acts as a custodian for the employee. Yes, that was fun. You liked it.)

Pros and cons of custodial brokerage accounts

The main reason for opening UTMA is to take advantage of the gift tax exemption to increase your investment for your child while providing more control over how money is invested and then spent. The main downside is that they offer fewer tax credits compared to a Roth IRA or 529 plan.

Unlike 529 plans, custodial accounts are subject to a “child tax” on unearned income up to a certain threshold. In 2023, any unearned income (that is, investment income) over $2,500 is taxed at the parent’s tax rate. And once the money is deposited into the deposit account, it cannot be taken back.

However, with UTMA, once your child is old enough, they can use the funds in their account for anything, whether it’s college tuition or a car. This is in contrast to the 529 plan, which requires the funds to be used to pay for their education. This means that if you know you’re only investing in your child’s future education, the 529 plan will offer more tax-deferred growth. But if you’re looking to supplement 529 and want more wiggle room about how your child’s funds can end up being spent, UTMA provides more flexibility.

(It’s also worth keeping in mind that UTMA may affect your child’s future eligibility for financial assistance. Read more about this here .)

How to open a custodial brokerage account

Parents, grandparents and guardians can open a deposit account with almost any brokerage or financial institution. These financial institutions set account terms and conditions, including initial investment requirements, minimum account balances, interest rates, and management fees. Usually these conditions are similar to those that are in any standard company reporting.

The minimum balance to open UTMA is usually between $500 and $2,000. Anyone can contribute to a custodial account, but due to gift tax laws, many contributions are limited to $15,000 ($30,000 for married couples) per child per year.

Beware of expensive third party apps

One rule to keep in mind when opening a custodial account for your children: don’t be fooled into paying unnecessary fees. You have the option of using a service like UNest to get started with your custodial brokerage account, and if you’re an inexperienced investor, pre-built portfolios can be a good way to get started.

However, the service fees for these apps may not be worth the recommendations they offer. For example, Investor Junkie shows how much you will pay UNest to manage your funds:

“…if you stick to the lowest monthly contribution of $25, you deposit $300 into your child’s custodial account for one year. But with a $2.99 ​​monthly fee, you pay 11.96% for UNest putting their money in.”

Compared to commission-free trading at most large institutions, UNest charges an absurdly high commission that will only be worth it with a larger account balance. Before you decide you need the help of an investment app, seek advice from your primary online broker.