Investing is one of the most exciting topics, especially if you are a teenager and the world ahead of you is wide open.
Learning how to invest as a minor can give you a tremendous head start for your financial future.
Early investing can have huge benefits, and teens who learn responsible money habits can have a huge advantage over their peers. If you are a teenager and want to learn more about finances, you can start with the basics and gradually learn the art of financial planning, saving, and investing.
Take it from the expert, Warren Buffett. He once said, “the best time to plant a tree was 20 years ago, the second-best time is now.”
Here are a few ways to start investing as a minor.
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Most people don’t think they can begin investing until they are an adult or over age 18.
This may be true, but there are certain types of accounts offered to minors that can be established by a parent or guardian. Some of these accounts can help you save for long-term goals such as education and retirement.
The most common type of account is a custodial account.
Check out our video on investing as a teenager below!
Minor accounts, created in part by the Uniform Transfers To Minors Act and the Uniform Gift To Minors Act (UTMA/UGMA), are excellent options if you are investing for your teenager.
You can establish these minor accounts and begin investing within them almost immediately. This money can be used for any purpose including education expenses as well as any other needs the child may have.
The profit from these investment accounts will be taxed according to the child's tax rate or potentially the parent's tax rates if the child makes enough money and is subject to kiddie tax limitations.
Custodial UGMA/UTMA accounts are one of the excellent options for teenagers who want to begin investing. The parents have the final decision over the account until the child reaches 18 or 21 (depending on the State).
At the age of majority, ownership of the account will be transferred fully to the child and the parent will no longer have any control over the account.
The child will be free to cash out the account for whatever they please, so it's important to talk with your child about the intended purpose of the account beforehand.
Retirement plans are a great way to save for your future.
No matter what, if you are investing for a teenager or an adult, it's never too early to start planning for retirement. The earlier you begin planning, the better off you will be. This is thanks to something called compound interest!
There are many different types of retirement accounts, but the most popular are the Traditional IRA or the Roth IRA.
The Traditional IRA is a tax-deferred retirement account. This means you contribute to the account with pre-tax dollars.
When you take distributions in retirement from a Traditional IRA, you will pay ordinary income taxes.
Roth IRAs are slightly different, as contributions are after-tax.
This means the account grows tax-free and when you take distributions in retirement they will be completely tax-free.
For both Traditional and Roth IRAs you cannot take a qualified distribution until age 59 ½. If you take an early distribution, you will be subject to a 10% penalty and income taxes.
However, there are certain exceptions to the early withdrawal penalty. You can read more about these exceptions here.
Typically, younger people tend to gravitate toward Roth IRAs because they assume that they are in a lower tax bracket now than they will be in the future.
For example, if you're currently paying 12% in taxes and assume that in the future you'll be in a 25% tax bracket, you'd be better off to pay the 12% now instead of 25% later.
With both Traditional IRAs and Roth IRAs, your child will need to have earned income. Without earned income, you are not allowed to contribute to an IRA.
So if you're thinking of contributing to a Roth IRA for a younger child you might need to find creative ways for them to earn income.
For most situations, the Roth IRA will be best since children are in a low tax bracket now (typically 0%) and will be at a higher tax bracket later in life when they take distributions from the account. This way the dollars within the minor Roth IRA may never get taxed.
You can set up Minor Roth IRAs at a variety of brokers.
There are many options available so we recommend doing as much research as possible before jumping in:
You can also invest in qualified education savings accounts for your teen. Planning for your teen's education is a good way to stay ahead of hefty college expenses.
This is a savings plan offered by most states that allows individuals to save for college or k-12 education expenses. You may also use 529 plans to pay student loans and internship programs.
The annual contribution limit for 529 plans is $15,000 and most States offer a tax deduction for your contribution. There is also the ability to contribute five years' worth of contributions at once and fund up to $75,000 into a 529 plan in one year.
Distributions within these accounts are tax-free by the IRS if used for qualified education expenses. Parents, guardians, grandparents, or even family friends can establish a 529 account and choose their specified beneficiary.
If a child decides not to attend college or there are excess funds in a 529 plan, the funds can easily be transferred to another family member or be withdrawn for non-education usage.
If you choose to withdraw funds for non-education expenses, there will be a 10% penalty on any earnings in the account.
An ESA is a savings plan established by the federal government which allows individuals to contribute up to $2,000 per year per beneficiary.
Unlike a 529 plan, there is no tax deduction for the contribution. This should give you pause when considering this over a 529 plan.
Similar to a 529 plan, distributions will be tax-free if used for qualified education expenses. However, the ESA must be used before the beneficiary reaches age 30 or you will be subject to tax and penalties.
Contributions to ESA accounts may also be subject to income phase-out limitations. This means if you make over a certain amount of money, you will not be eligible to contribute.
Similar to 529 plans, these funds can either be used for K-12 private education or college expenses.
Currently, there are not many compelling reasons to choose an ESA over a 529 plan.
Investing as a teenager has never been easier.
However, if you are under age 18 then you may need the assistance of a parent or guardian.
Whether you are trying to save for retirement, education, or your future, there are many options available for teenagers.
If you’d like to learn more about investing basics check out our Beginners Guide to Investing in the Stock Market.