Most people start investing when they start their first job. They often start out with a 401k or Roth IRA, but what if you’re still in school? For kids who are just beginning to learn about money and saving, it’s never too early to start investing. In this article, we’ll go over why it’s important for kids to start investing as soon as possible and how custodial accounts can help them save on taxes!
1. Why Kids Should Start Investing as Early As Possible
Kids are often told to start saving for retirement as soon as they can, but what if you’re still in school?
Investing early is important because the earlier you start investing, the more time your money has to grow. If you invest $1,000 each year starting at age 20 and then stop investing when you turn 30, that initial investment will be worth $263,244 by age 65 if it earns an average annual return of 8%.
However, if you invest $1,000 at age 30 and then stop investing when it’s time for retirement, that initial investment will only be worth about $200,887.
As you can see, time matters. Starting to invest while in school, even with little amounts of money, can pay huge returns down the road.
The earlier you start investing, the more time your money has to grow.
Investing early is important because it gives kids an opportunity to start building their own wealth and learn valuable skills that can make them smarter investors in the future!
Though, if they’re underage, kids can’t invest by themselves. They’ll need help from an adult to open a special investment account for kids called a custodial account.
2: How Custodial Accounts Can Help Kids Invest
A custodial account is a type of account where parents or legal guardians act as the custodian and have legal responsibility for managing a child’s money.
A custodial account can be used to start saving tax-free, up to the IRS annual financial gift exclusion amount ($15,000 per year) during any age from infancy until adulthood (18), after which an adult needs their own Social Security number in order to start.
Custodial accounts are a great way to start investing as early as possible because they’re tax-advantaged for certain amounts of investment income and can start building wealth that can compound over time.
The earlier you start investing, the more money is able to grow!
Custodial accounts start accumulating taxes at certain investment income levels, but they only start doing so past $1,100 of annual income. Between $1,101 and $2,200 of investment income, earnings on the account get levied at the beneficiary’s rate. Above that, the investment income gets taxed at the parent or guardian’s tax bracket.
That means a child earning $500 in dividends with no other income will pay nothing in federal income taxes, but if they earn $1,500 in dividends, they’ll only pay taxes on $400 of that income. If they ern $2,500, they pay taxes on the earnings between $1,101 and $2,200 at the child’s rate and then $2,201 to $2,500 at the parent or guardian’s rate.
3. The Benefits of Custodial Accounts for Kids
Starting an investment account as soon as possible builds valuable skills and teaches kids how investments work. They’re also easier than opening up their own custodial Roth IRA for kids because they don’t need earned income.
Finally, these types of accounts are easy because parents or legal guardians have full responsibility over the account and can start saving for their child’s future.
You can even pair custodial accounts with banking apps for minors that come with the best debit cards for kids and teens.
Greenlight Card is a debit card that makes it easy to manage your children’s money and track their spending.
You can use the card anywhere you see the Visa logo, so you don’t need cash or checks to pay for things. Plus, the app lets you set parental controls and safeguards that prevent your children from shopping at certain merchants.
4. The Drawbacks of Custodial Accounts
This discussion wouldn’t be complete without a discussion of the drawbacks of custodial accounts.
First, these accounts start accumulating taxes at certain investment income levels.
It’s also important to make sure the parent or guardian is capable of making decisions about their child’s money because if they’re not smart with savings and investments, it can have negative impacts on a kids’ future.
Finally, funds held in a custodial account usually count toward a child’s eligibility to pay for their own college expenses. The funds held in the account are considered the property of the child, giving them a higher weighting for their financial resources available to finance their own education as compared to funds provided by parents.
This disparity can make parents and guardians think twice about how much money they should save in these accounts. If the funds going into the account are earmarked specifically for college or educational expenses, you might consider investing through a 529 plan instead.
These plans provide special tax benefits for funds going toward educational expenses, making gains tax-free if they go to pay for qualified educational expenses.
Another item of note on custodial accounts is that when learning how to gift stock or other financial assets to a minor’s custodial account, these gifts become irrevocable. This means the donor cannot get the assets back from the custodian.