Everything You Need to Know About How to Buy Stock for a Child

April 16, 2021
financial literacy

When a child comes of age, they have a lot of huge decisions facing them: where to go to college (or whether to go at all), what career to choose, where to live, and what kind of life to lead.

As a teenager or young adult, these decisions can feel overwhelming. And having to limit your choices (and dreams) based on financial restrictions can be crushing. 

If you want to help a child in your life have the freedom to choose and chase their dreams when they grow up, investing in their financial future is the way to go. 

In this article, we’ll walk you through how to buy stock for children in your life and what considerations you should keep in mind when deciding whether this is the best type of financial investment for your loved one. 

The Basics of How to Buy Stocks

Before we dive into buying stocks for a child, let’s first cover how to buy stocks overall. If you’re new to investing or have so far only invested in your company’s 401(k), then the idea of buying stock might seem a bit confusing.

When you buy stock, you’re buying a piece of ownership in a company. 

In general, investors make money in one of two ways. Either the stock price increases (which results in a capital gain for investors when they sell), or the company shares its profits with investors in the form of dividends.

But buying stock in your favorite company isn’t like buying one of the products they sell. Stocks (also known as equities) are bought and sold on stock exchanges.

Individual investors go through brokers to buy stock. Brokers are essentially the middlemen between the stock exchange and the investor. These days, most investors work with online brokerage firms.

Can You Open a Brokerage Account For a Child?

The next question we have to address when it comes to buying stock for kids is whether children can actually have a brokerage account. The answer is: sort of.

Most states and brokerage firms require that individuals be 18 years of age before opening a traditional brokerage account. In some states, the minimum age is 21. But that doesn’t necessarily mean you can’t invest for a child.

Children can legally own stocks and other investments. They just can’t open a brokerage account to buy them on their own. 

The good news is that there are plenty of options that will help you buy stocks for the children in your life. Rather than buying stocks through an individual brokerage account, you can take advantage of other investment vehicles.

How to Buy Stocks for Children

Buying stocks for the children in your life doesn’t have to be complicated. In just a few simple steps, you can set up an account and start contributing to give that money time to grow. 

Here’s how:

1. Decide on an investment goal

One of the most important steps in investing is setting specific goals. These goals will help to guide your investment choices and decide how much you should save.

For many families, the goal is to save for a child’s college education. Using a compound interest calculator, you can experiment with different contribution amounts to see how much you should invest per month to meet that goal.

For example, let’s say you wanted to save $60,000 to help cover the cost of a child’s college education. 

If you rely on the average stock market return of 10%, you’d only have to contribute around $110 per month from the time they’re born to get to your $60,000 goal by the time that child turns 18.

2. Choose the right type of account

As we discussed earlier, children can’t open an individual brokerage account to buy stock. Instead, you can take advantage of unique investment vehicles specifically designed to invest for children.

Here are four popular options:

529 plan

A 529 college savings plan is a type of investment account that parents and other loved ones can use to save for a child’s education expenses.

These plans come with certain tax advantages. The money you contribute grows tax-free, and you can withdraw it tax-free as long as you use it for college expenses.

The drawback of this type of account is that they lack flexibility. 

They’re intended specifically for higher education expenses. If you spend the money on anything else, you’ll pay a penalty. This could be a huge problem if the child decides not to attend college after all.

Custodial IRA

A custodial individual retirement account (IRA) is a way for loved ones to start saving for a child’s retirement. These accounts come with excellent tax benefits. They also allow you to start early, meaning the child will have to save considerably less during adulthood for their retirement.

The problem is that, like the 529 accounts, custodial IRAs are intended for a very specific purpose. And you might pay penalties if you try to use that money for anything else.

Parent’s brokerage account

Another way for adults to buy stocks for a child is to simply use their own brokerage account. You can buy stock in your own account, knowing that any profits from that stock will go to the child.

The benefit of this route is simplicity. That’s especially true if you already have an existing brokerage account.

But there are a couple of downsides. First, the child doesn’t really own the stock. You do. Second, gains on the stock will be taxed at your tax rate instead of the child’s. Chances are, your tax rate is higher. 

Custodial brokerage account

A custodial account is a type of brokerage account that an adult opens on behalf of a child in their life. The adult, known as the custodian, manages the account and makes all of the investment decisions. Then, once the child reaches adulthood, they take control of the account.

Any contributions to a custodial account are irrevocable financial gifts. Once you put the money in, you can’t take it back. It legally belongs to the child.

The biggest benefit of custodial brokerage accounts is their flexibility. 

Once the child reaches adulthood, they can use the assets in the account for anything without penalty. These accounts can also hold many different types of investments. 

EarlyBird is an example of an investing platform that adults can use to open an UGMA account, which is a type of custodial brokerage account.

3. Open and fund your account

Once you’ve chosen the right type of account, it’s time to open and fund it. When you choose EarlyBird for your custodial account, you can open it in just a few simple steps. Then you can start contributing.

When funding a child’s custodial account, be sure to consider your investment goal and how much you need to contribute each month to reach that goal. 

Setting up monthly contributions is an effective way of making sure you stick to that goal.

4. Determine your asset allocation

The next step is choosing your assets. This is the part where you actually buy stocks for the child in your life. 

Except in most cases, long-term investing doesn’t involve buying individual stocks. Instead, it involves investing in funds that hold collections of stocks and/or bonds. 

EarlyBird makes it easy to choose your investments by offering five different exchange-traded fund (ETF) portfolios, ranging from conservative to aggressive. 

EarlyBird also allows families to allocate up to 5% of assets to values-based funds that support causes such as diversity and environmental protection. 

Through these values-based funds, you can grow your money while also teaching a child about the importance of investing in causes that are important to them.

5. Invite friends and family to contribute

One of the greatest features of EarlyBird is how simple it is to invite friends and family to join in. When you’re saving for a goal related to a child’s future, loved ones will want to be a part of it. And with EarlyBird, they can.

In just a few simple steps, loved ones can contribute to a child’s account. While they’re at it, they can leave a short video message that will serve as a keepsake for the child.

Things to Consider When Buying Stock for Kids

There’s a lot to consider when buying stocks for a child. Here are just a few of the things to keep in mind:

  • Time horizon: Time horizon refers to the amount of time before you plan to use the money you’re investing. In general, experts recommend reducing your portfolio risk as your time horizon shortens.
  • Diversification: One of the core principles of long-term investing, diversifying your portfolio helps reduce your chances of losing money. EarlyBird takes care of diversification for you through its ETF portfolios.
  • Gift taxes: If you give more than $15,000 to another person in a single year, you may be required to file a gift tax return. Be sure to consult an accountant if this is the case.
  • Taxes on earnings: Earnings from investments are taxable, and custodial accounts are no exception. In an UGMA account, the first $1,100 a child earns is tax-free. The next $1,100 is taxed at the child’s tax rate. Consult an accountant for help properly claiming these earnings.
  • Account ownership: All assets in a custodial account legally belong to the child. Once they reach the age of either 18 or 21 (depending on the state), they take full control of the account and the assets within. They can spend that money on anything they’d like. So while you may have saved that money with a specific purpose in mind, there’s no way to require them to spend it on that same purpose.

Conclusion

Most states don’t allow kids to open brokerage accounts, but that doesn’t mean you can’t buy stock for them.

Custodial brokerage accounts allow adults to invest for kids while staying in the driver’s seat when choosing investments. The money will empower that child to reach their goals and make sure that every door is open to them.

EarlyBird makes it easy for anyone in a child’s life to collectively invest in their lives. Download EarlyBird on the app store today to start investing in the kids you love.