One idea I had for a neat Christmas gift for my 5-year-old nephew is starting him a brokerage account and buying him stocks on a monthly basis. I could contribute some tiny amount (maybe $20 a month), and hopefully get his mom and grandma to join in so that by the time he’s 18, he’ll have a decent chunk of change he can use for college or a down-payment on a house or to buy a 1965 Mustang. Whatever.
The problem is, how exactly does one go about buying stocks for a relative who happens to be a child? I’ve been doing some Web research, and I finally figured it out: Open what’s known as a UGMA & UTMA Custodial Account for a Minor. While I’m still parsing through the legalities, here’s what I know so far (picked up with a lot of help from Fairmark.com):
- UGMA/UTMA accounts must be opened by the child’s parent/custodian, although the account will be created in the child’s name.
- Contributions to the fund are legal gifts as governed by the 1956 Uniform Gifts to Minors Act (UGMA) and the 1986 Uniform Transfers to Minors Act (UTMA). Once you’ve contributed money to the fund, it belongs to the child (so don’t bother trying to get the cash back down the road – you won’t be able to).
- The child’s custodian (and/or someone they appoint) will have control of the funds until the child reaches a specified age – typically 18. With a custodial account, you can specify that the child not have access to the funds up to the age of 21.
- Cash can be withdrawn from the fund by the custodian but ONLY if it’s used to benefit the child.
- All property held in the custodial account belongs to the child, and that means the child is responsible for taxes (think “kiddie taxes”) and other fees associated with the account.
- Custodial accounts could negatively impact a child’s ability to qualify for financial aid for college. I think this concern is relatively minor if the funds are set to release when the child turns 18, and you’re confident he or she will put the money to good use.
- Since custodial funds can be used to benefit a child before that child has full access to the funds, the custodian could, potentially, tap the funds to buy a computer or car for the child. This MUST be documented. Be sure you trust the custodian of a fund to handle it responsibly.
- If you think the child is definitely going to college, a Section 529 Savings Plan or a Coverdell Account might make better choices than a custodial brokerage account. They offer tax advantages provided the money is ultimately used for higher education.
- If your child’s investment income exceeds $950, he or she will have to start paying taxes on that income. If your child’s investment income exceeds $1,900, he or she will have to pay a special “kiddie tax,” which will be taxed at the custodian’s rate. Think about it, unless you’re dealing with a substantial chunk of change, this shouldn’t be a big issue. You’d only hit $950 in investment income if your child’s account had say $9,500 in it that earned 10 percent a year in interest.
Ready to sign your child up for a brokerage account? I’d recommend talking to an accountant first. Still, Scottrade makes it a fairly simple process with their forms here.
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