Investing in the stock market can be an incredible way to build a nest egg.
The average S&P 500 index has generated an annual average return of over the past decade — so if a child starts investing early, they should be able to stride into adulthood with the gift of financial freedom.
Unfortunately for financially literate kids, buying stock isn’t really an option. That’s why adults have to take it upon themselves to gift stock to the children in their lives in order to get them on the stock market ladder.
But gifting stock to a child isn’t always super straightforward. You’ve got a couple of different options, and each one has its own set of pros and cons.
This guide will explain why you should gift stock to a child, how you can gift stock to a child, and how gifted stock is taxed.
Why Should You Gift Stock to a Child?
If you want to kickstart a child’s financial future, you should definitely consider investing in stocks.
Why gift stock to a child? Simply put, investing in the stock market will make your money work harder for you.
Let’s crunch the numbers. According to leading investment bank Goldman Sachs, the average ten-year stock market return has clocked in at an average of 9.2% every year for the last 140 years.
But that’s just the tip of the iceberg regarding stock investment options. The S&P 500 has done even better. Over the last ten years, it’s brought in average returns of 10.29%.
If you compare those returns against cash, there’s not going to be much of a contest. You’re not going to find many savings vehicles offering that sort of compound interest rate over time.
More important still, when you’re saving cash for a child you love, you could end up getting outstripped by inflation.
Translation: by the time the child you love hits adulthood, the cash you’ve stowed away could be worth less in terms of spending power than when you started saving.
That’s why gifting stock is a great option for building a nest egg. Unfortunately, kids can’t buy stock.
Generally speaking, you need to be at least 18 years old to buy stock.
That’s because the most common way to purchase stock shares is through a brokerage account — and most of the brokerages you’re going to come into contact with will require you to be at least 18 to set up a brokerage account.
That being said, there are a few flexible options you may want to check out if you want to help children invest in the stock market. One of the easiest ways to gift stock to a child is through a UGMA custodial account.
But we’ll cover custodial accounts in just a minute. First, let’s talk about life skills.
Investing in stock is a great gift idea for a child because they can’t buy stock themselves — and it empowers kids with the gift of financial security. After all, accrued interest and a great return on investment (ROI) will ensure the kids you love end up building wealth long before they hit adulthood.
Yet another reason you should gift stock to children is that it teaches them valuable financial literacy skills.
By gifting stock to a child, you’ll be able to educate that young person on some fundamental financial concepts. When you invest in the stock market, you can show the kids in your life first-hand how the stock market works.
As they get older, get them involved in the investment decisions you’re making on their behalf. Explain risk and reward, as well as the benefits of compound interest and saving.
By doing so, the child will grow up with a greater sense of how investments work — and a greater appreciation of the financial sacrifices you’ve made for them along the way.
How Can You Gift Stock to a Child?
OK, so we’ve covered why you should gift stock to a child. Now, let’s explore how you actually go about doing it.
Gifting stock to an adult is incredibly simple. If the person you’re gifting stock to is over the age of 18, you can just use your brokerage account to transfer stock shares to their account. That’s all there is to it.
But if you want to gift stock to a child, the process can be slightly more complicated. A lot of adults tend to set aside stock within their existing brokerage accounts with the intent to pass those shares along after the kids they love have grown up.
The problem here is two-fold.
First off, your plans might change.
You might end up failing to pass those assets along, in which case the children you were holding those shares for are going to miss out.
The second issue is tax-related. If you hold onto those shares in your name and they increase in value, you’ll be taxed on any capital gain you make at your adult tax rate.
Fortunately, there are a couple of popular investment vehicles available to adults that solve both of these issues: custodial accounts and 529 plans.
Both options have their own sets of pros and cons, so we’ll quickly break down the difference for you.
UGMA custodial accounts
If you want to gift shares to children, a great option is a UGMA custodial account.
Named after the Uniform Gifts to Minors Act that created it, a UGMA custodial account is a tax-efficient investment vehicle designed to help adults save for a child’s financial future.
When an adult sets up a custodial account, they’re effectively creating a holding account for all the assets they’d like to pass on to a child when they come of age.
You, as the adult, must serve as the account’s custodian. This means you’re responsible for managing the investments held in the account on behalf of an appointed child beneficiary.
You’ll then need to keep on managing those assets until the child beneficiary reaches the so-called “age of majority.” The age of majority varies from state to state, but it’s usually either going to be 18 or 21.
After the child reaches the age of majority in their state, the custodianship ceases to exist.
All the assets you’ve saved up in the account will then pass onto the (now grown-up) child’s control.
UGMA custodial accounts are designed to save a wide range of financial assets — including cash, stocks, bonds, exchange-traded funds (ETFs), and mutual fund shares.
More important still, you’re allowed to contribute as many assets as you’d like to a custodial account. Unlike some other investment vehicles like a 529 plan or a Roth IRA, there are no contribution limits when you gift stock into a custodial account.
But while your contributions can be as big as you’d like, it’s important to note that you’ll need to pay tax on any contributions above your annual gift tax amount.
For 2022, the federal gift tax limit was $16,000 per recipient (in 2023, it is $17,000)— but we’ll cover the gift tax more in a minute.
Another point to consider is that everything in a custodial account is the legal property of the child beneficiary.
Although you’re managing the account as a custodian, the stock shares in the account belong to them. That protects the assets from you, but it also helps with your family’s tax burden.
Because the stock belongs to the child, the IRS taxes any income those shares generate — up to a certain amount — at the child’s lower tax rate. That could end up saving you quite a bit of money.
Finally, you should remember that custodian accounts are flexible when it comes to withdrawals.
As a custodian, you can withdraw funds from a custodial account as long as it’s for the child beneficiary. Better yet, when the child comes of age, they can use the assets in the account for whatever they’d like to spend it on.
If you’d like to invest in stocks for a child, a 529 plan is another popular option — although it’s going to be more limited in scope than a UGMA custodial account.
A 529 is a college savings plan that allows families to save cash for a child’s future college expenses. 529 plans can also be used to pay for K-12 tuition and other educational expenses.
Each state offers its own 529 plan options, which tend to be composed of low-risk investment portfolios. Each portfolio has its own set of stock options in the form of mutual fund shares — but you tend to be quite limited in terms of choice.
The rules in your state will dictate the account type, platform, and stock options available to you.
After placing money into a 529 plan, your portfolio will then grow over time until the child needs it. You’re allowed to make cash withdrawals from a 529 plan whenever you need to. But to avoid penalties, withdrawals have got to be for a qualified education expense like college tuition fees.
A lot of adults are certainly going to run into a situation in which the child they’re saving for needs cash for college.
But it’s important to remember that 529 plan providers usually maintain super-specific definitions of what constitutes a qualified education expense. Things like off-campus accommodation or a new laptop aren’t usually going to qualify.
Just like a UGMA account, the assets in a 529 plan belong to the child beneficiary rather than the adult managing the account.
With a 529 plan, you’re also going to benefit from a major tax benefit — because everything you invest in a 529 can grow in the account tax-free. You also won’t be taxed for any withdrawals, as long as they’re made for qualified expenses.
The only real drawback here, apart from limited choice and rigid withdrawal rules, is that 529s have contribution limits. These tend to be aggregate limits set by each state. But you need to be aware when investing for a child that, by choosing a 529, your savings potential will be capped.
Do You Have to Pay Tax on Gifted Shares?
The short answer is: maybe.
Thanks to the IRS gift tax, you're allowed to gift a wide range of property and assets to a child up to a certain value.
That range of property includes stock shares, and the tax-free amount you’re allowed to gift annually is $17,000 per person (for 2023). This is what’s known as your annual gift tax limit. If you and your spouse jointly file your taxes, then you’re allowed to gift up to a combined amount of $34,000 per year.
Because the gift tax is per person, you could gift $17,000 worth of stock to your son, $17,000 to your daughter, and $17,000 to your cousin all in the same year without having to report the gifts to the IRS.
If you gift over $17,000 to any one person, you’ll need to submit a gift tax return to the IRS. This is done at the same time you file your annual tax return using IRS Form 709.
It’s also important to note that anything you gift above your annual limit of $17,000 per person then feeds into your lifetime gift tax limit. In 2023, the lifetime gift tax limit is $12.92 million.
But the gift tax isn’t the only tax implication you need to consider when gifting shares to children.
You may also need to pay a capital gains tax or income tax on gifted shares. This will depend a lot on the type of account you’re using to hold the shares and how you transfer shares to a child.
For example, if you have shares in a 529 plan, they’re allowed to grow tax-free. You won’t be expected to pay anything to the IRS if your shares increase in value.
If you have shares in a custodial account, you’ll likely need to pay taxes for any gains your holdings generate (like a dividend). That means that the gains will need to be reported to the IRS — but because the assets belong to the child, they’re taxed at the child’s tax rate rather than your adult rate, up to a set threshold (currently $2,500.)
Let’s be honest: we all worry about the kids we love. But you can alleviate some of those concerns by making sure you’ve invested enough in that child’s future so that they don’t have to stress about money when they grow up.
Investing in stock is probably one of the most efficient ways to do it.
Unfortunately, children aren’t old enough to buy stock — so if you want to invest in stock shares for a child in your life, you’re going to have to purchase it on their behalf.
Fortunately, with an investment vehicle like a custodial account, you’re able to purchase a range of asset classes and store them in a tax-efficient way for the kids you love.
Download the EarlyBird app now to learn more about financially investing in the future of the children in your life.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.