That doesn’t mean you have to sit around and wait until you’re 18 or 21 to begin investing. There are various custodial type accounts that you can set up that can allow you to get started now. This can include saving and funding an account, as well as participating in making investment decisions.
The catch is that you will need help from a parent, guardian, or grandparent. That may result in a limited investment experience, but it will still be an excellent start. Not only will you begin to learn the ropes of investing early in life, but you’ll also begin saving and building wealth before you even become an adult. And when it comes to investing, the earlier you start, the stronger you finish.
Let’s take a look at three broad investment account types that can provide investment options for teenagers. In any one of the three, you’ll have an opportunity to invest in mutual funds or exchange traded funds (ETFs), or even individual stocks and real estate investment trusts (REITs).
Custodial Traditional IRAs
Traditional IRA accounts are available to anyone who has earned income. That means that a teenager can fund an account with income earned from a part-time job, or even a summer job. She can fund the account with up to $5,500 per year, and hold the money in a self-directed investment brokerage account.
With a traditional IRA, a teenager will also get a tax deduction for making the contribution. Any funds contributed, up to $5,500, will reduce her income for federal and (usually) state income tax purposes. However, this isn’t a deciding advantage, since a minor is not required to file a tax return until her income reaches $6,500 in 2018. But if her income will exceed this threshold, a traditional IRA could be the right choice
One of the major advantages with IRAs is that they come with tax-deferred accumulation of investment earnings. For a teenager, that can provide an incredible lifelong compounding benefit.
If a 13-year-old invests an average of $3,000 per year for five years, and earns an average investment return of 7% per year, the account will grow to $17,253 by age 18. Even if he stopped funding the account, and just let it grow, it will reach $414,861 by the time he turns 65.
Both the funds contributed to the account, and the investment earnings, aren’t taxable until they are withdrawn after age 59 ½. Withdrawals taken before that age are subject to ordinary income tax, plus a 10% early withdrawal penalty tax.
There’s still another advantage in having an IRA. Later in life, the teenager will be able to make penalty free withdrawals from the account in order to either make a down payment on a first-time home purchase, or for education purposes.
Custodial Roth IRAs
Roth IRAs have similar benefits to traditional IRAs. They allow for tax-deferred accumulation of investment earnings. They also permit penalty free withdrawals for the purchase of a first-time home, or for educational purposes.
But that’s where the similarities end.
While traditional IRAs are simply tax-deferred – meaning the funds are taxable upon withdrawal – funds withdrawn from a Roth IRA account can be taken tax-free once you reach age 59 ½, and have been participating in the plan for at least five years. A teenager can be building tax-free income for retirement before even reaching adulthood!
Roth IRAs also don’t enable you to make tax deductible contributions. But that creates another unique advantage: contributions withdrawn from a Roth IRA can be taken tax-free and penalty free at any time. This is a massive advantage for a teenager whose building an investment account, and likely to need the funds well before retirement.
What’s more, the IRS doesn’t prorate withdrawals between contributions and investment earnings, the way it does with traditional IRAs. The full amount of the teen’s contributions will be available for withdrawal.
Let’s look at this based on the example above of the 13-year-old who contributes $3,000 per year to the account, and has $17,253 by age 18. His account includes $15,000 of contributions, and $2,253 in accumulated investment earnings. He can withdraw up to $15,000 free from income taxes and penalties. The remaining $2,253 in accumulated investment earnings can continue to grow.
This is an excellent option for a young person to have, since it’s not possible to know exactly what financial needs will come up in the future. The teen will have the option either to withdraw funds early as needed, or to let them grow for retirement. Perfect!
Opening a Custodial Traditional or Roth IRA for a Teenager
Not all investment brokerages will permit you to open an IRA account for a minor child. Some brokers and mutual fund companies will allow you to set up a custodial IRA. You must provide your child’s Social Security number, but you will remain the custodian of the account until your child reaches the legal age of majority in your state. That can be anywhere between 18 and 21. In the meantime, you will have control over the account, including investment decision authority.
But even though that isn’t a pure investment account in your teenager’s name and under her control, it’s the next best thing. You can maintain legal control over the account, while allowing the teen to fully participate in investment decisions.
That’s an excellent start, since very few teenagers have the knowledge and experience to make investment decisions by themselves. But it’s an excellent opportunity for them to learn. You can open an account, then have the teenager choose the investments – subject to your final approval. As a teenager grows more investment savvy, she could begin choosing and managing the account more actively. Eventually, she will make the investment decisions, and you – as account custodian – will execute the trades.
Investment Brokers that Offer Custodial IRAs
Not all investment brokerage companies offer custodial IRAs. But some that do offer both traditional and Roth IRAs for teenagers (and the minimum initial investment requirement) include:
Until and unless robo-advisors make custodial IRAs available for minors, the brokerage firms listed above can work well.
Uniform Transfers to Minors Accounts (UTMA) and Uniform Gifts to Minors Act (UGMA)
UTMA and UGMA accounts can be set up with a wide variety of investment accounts. Funds invested in the account can be used for any purpose. That includes current needs for the teenager, to funding a college education.
A UTMA/UGMA account is created for the benefit of a minor. It’s controlled by a custodian – usually a parent – until the child reaches the age of majority in their state.
Investment income in the account is taxed at the child’s rate. If the child is under age 19, or under age 24 and a full-time student, the tax liability is computed like this:
- The first $1,050 of investment income is tax-free.
- The next $1,050 is taxed at 10%.
- Income above $2,100 is taxed at the parent’s marginal tax rate. That could be as high as 39.6%. This is what is often referred to as the “kiddie tax”.
UTMA/UGMA accounts make a lot of sense if the investment income is less than $2,100. If the parents are in a high tax bracket, these accounts become less attractive.
Still, they can be excellent ways for teenagers to begin investing. The teenager can participate in the investment management.
What’s more, there are far more places to hold a UTMA/UGMA account. These can include banks, mutual funds, and investment brokers, including those listed above.
There’s no limit on the contributions but they rarely exceed $14,000 per year. That’s the threshold beyond which the donor will have to pay gift taxes on the amount contributed.
Final Thoughts on Investment Options for Teenagers
Investment options for teenagers aren’t nearly as numerous as they are for adults. Teenagers are minors and lack the legal authority to own or manage an investment account. But whether you use a custodial IRA or a UTMA/UGMA account, it’s an opportunity for a teenager to begin learning the investment process.
You won’t have direct ownership of the account, nor can you actually execute trades. However, you can get involved in investment research, and select the securities or funds that you want to invest in. That will give you a real opportunity to get hands-on experience investing before “going solo” when you’re legally an adult.
Your future self will thank you for it! You won’t learn investment management in high school or college. Most people learn only with real-world experience. Whether you choose a traditional or Roth IRA, or a UTMA/UGMA account, you’ll be fast forwarding your investment education, as well as your future wealth.
Good Financial Cents, and author of the personal finance book Soldier of Finance. He was a financial planner for 16+ years having founded, Alliance Wealth Management, a SEC Registered Investment Advisory firm, before selling it to focus on his passion – educating the masses on the importance of financial freedom through this blog, his podcast, and YouTube channel.
Jeff holds a Bachelors in Science in Finance and minor in Accounting from Southern Illinois University – Carbondale. In addition to his CFP® designation, he also earned the marks of AAMS® – Accredited Asset Management Specialist – and CRPC® – Chartered Retirement Planning Counselor.
While a practicing financial advisor, Jeff was named to Investopedia’s distinguished list of Top 100 advisors (as high as #6) multiple times and CNBC’s Digital Advisory Council.
Jeff is an Iraqi combat veteran and served 9 years in the Army National Guard. His work is regularly featured in Forbes, Business Insider, Inc.com and Entrepreneur.