Setting Up an Investment Account for Children

Many parents provide little in the way of financial resources directly to their children other than perhaps help with college expenses or initial assets such as a car.  Others provide resources as needed, like help with rent or money for necessities, but continue to treat their offspring as a child with tight control over the financial decisions rather than as an adult who can make their own decisions provided the assets needed.  Providing little may build character and pride for those who succeed, but increases the chances of failure since what would be small events for someone with some money set aside become huge events for those without.  Doing so also increases the chance of them buying many things through loans, meaning that resources gained through work will be lost to interest.

For those parents who are able, meaning those who have lived below their means and therefore have the resources to do so, a better option is to set their children up with an investment account.  If this is started while the child is a tween or a young teenager, the child will be able to learn investing skills under the guidance of a parent, making them better ready to manage their own investing when they leave home.  If they then have a portfolio of assets when they start the adult stage of their lives, they will have a safety net when needed and also have the means to acquire needed items with less debt, meaning that more of their effort at work will go into building assets and providing necessities and less will go to interest.  This will be like making perhaps ten times as much over their working lifetimes.

The steps for setting up an account and getting your children learning about investing are as follows:

1.  Decide whether individual stocks or mutual funds are more appropriate.  Based on the age when they are starting and the consequences of bad investment, this is probably one of the best times to be investing in individual stocks.  Many investors may not want to take the time required to pick stocks or deal with the fluctuations in value, however, in which case mutual funds would be the better choice.

2.  Determine where to setup an account.  For individual stocks or ETF buying, this would be with a broker, either in person or online.  For mutual funds, an account should be setup at one of the mutual fund companies.  Because they are a minor a parent will need to be the custodian and sign things as needed.

3.  Determine how to fund the accounts.  The easiest way to fund accounts is using the gift exemption, which allows parents to give up to $14,000 each ($28,000) per couple to their children per year.  There are also ways to give more without incurring tax penalties, but these reduce the amount that will be tax-free in an inheritance.  See a CPA for more details.  Realize that if they start making money investing that they will soon need to file income tax returns.

4.  Sit down with them and choose investments.  This, or course, involves teaching them how to invest.  You want them to have some say in the selection of stocks or funds so that they learn the skills needed but not make really bad choices.  If choosing individual stocks, one method is to select a group of stocks and then allow the child to determine which of the group to purchase.  With mutual funds, the parent can specify the types of funds to purchase and then the child can select the specific funds.  For example, the parent could specify buying a large cap and a small cap growth fund.

5.  Get them involved with the paperwork and the taxes.  Part of managing their accounts is knowing how to store the needed information and prepare the taxes each year.  Show them how to save and track the cost basis for their investments, what information will be needed should an audit occur, and how to prepare and file the tax paperwork.  Even if they do not do the taxes directly, they should still study the returns and verify that the information is correct.  Note that using an accountant is often a good choice if you invest since the rules can be very complicated.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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