Children and Investment Accounts | What Age is Right to Start?

With markets doing phenomenally well the last few years, lots of parents are thinking of ways to give their kids a head start on saving and building wealth. Money markets and certificates of deposit offer rates barely higher than inflation, and don’t offer a lot of potential for significant growth. An investment account is a great way to give kids that first taste of managing their finances like an adult.

Exposing kids to investing in the market at an early age might also encourage them to focus on building wealth through investments as adults.

However, stock investments can be very volatile and subject to rapid fluctuations in value if assets are highly concentrated in just a few equities.

Once a parent decides to open an investment account for their child, the next question is “what’s the best age to open an investment account?” The answer depends on why an investment account is being opened.

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Kid’s Investment Account as Tax Savings Tool

Parents can shield investment income from taxation by placing it in a child’s name. If the main goal of opening an investment account for your kid is to save on taxes, then it is appropriate to open an investment account at any age.

Under the IRS’s “Kiddie Tax” rule, the first $1,000 of investment income is generally tax free for children without other income. The next $1,000 of investment income will be taxed at the child’s usually lower income tax rate.

That second $1,000 may be taxed at 0% or 10% depending on whether the dividends are qualified and whether capital gains are short-term or long-term. After the first $2,000 in investment income, the child’s investment income is taxed at the parent’s marginal tax rate.

Altogether, the Kiddie Tax rule offers tax breaks on up to $2,000 of investment income per child, with income above that level being taxed at essentially the same rate as it would be if earned by the parent.

Remember, this is a tax break on $2,000 of investment income, so the amount of invested assets from which tax can be shielded is much greater. For example, a $66,000 portfolio with a 3% dividend yield and no capital gains will produce just under $2,000 of investment income. With multiple kids, parents could “shelter” the income from a six figure investment portfolio.

Using an investment account as a tax shelter can get tricky, as the tax calculations under the Kiddie Tax rule can be complicated. In addition, the gift tax could be triggered if large amounts of money are being transferred back and forth between the parent’s account and the kid’s account.

However an investment account can be appropriately opened in the kid’s name if you are genuinely saving for the kid’s future. For example, college savings could be held in the kid’s investment account if a 529 isn’t desirable for whatever reason. A bequest from a grandparent to a child could be invested in a kid’s investment account.

Kid’s Investment Account as Educational Opportunity

For those parents without hundreds of thousands of dollars needing sheltering from the tax man, the best reason for opening an investment account for their kids will be to share the wonders of investing in the stock market with their offspring. Kids are great at learning by doing.

You can stick your favorite investment book in front of them and guarantee that within five minutes they will be sliding away from you trying to clean their room, mop the floor, or do anything to avoid reading an investment book. Don’t worry, some adults are like that, too!

At first, skip the investment books and lectures and start off the investing experience with something simple. A test account through a stock broker such as TD Ameritrade could be a nice starting point. Then purchase of a few shares of a company they like to get them excited about owning equities. If they are young and still into Disney movies and characters, have them research DIS and make that the first purchase.

For those kids old enough to own a cell phone, they might want to buy Apple (AAPL) or Google (GOOG) depending on their choice of phone operating system.

Around age eight, kids should be able to understand an account statement and look at their investments online. They can look at the number of shares they own and multiply the number of shares by the stock price to see the total value of that holding. Aside from exposing children to investing concepts at an early age, an investment account can lure kids into practicing addition, subtraction, and multiplication!

By the time kids are 11 or 12 and in middle school, they should be able to understand basic business concepts and look at company balance sheets (with a parent looking over their shoulder) to dig deeper into the financials of companies they own.

More advanced investment concepts like setting limit prices and looking at bid/ask spreads on individual stocks are appropriate for children entering their teen years.

The Perfect Age to Open an Investment Account

Any age is a perfect age to start a child’s investment account, but kids will learn the most from the account around age eight or older. The benefit of starting at a younger age is that the account has more time to grow.

If you want to get your child hooked on investing and watching their account values grow over time, the rules are the same as for adults: more time in the market equals more growth long-term. As they progress through their preteen years into high school, you can make a point to review the account values with your child and review any stock splits or dividends as they occur.

My parents started a small mutual fund account for me when I was around eight or nine years old that initially had just a couple thousand dollars in it.

I kept the investment account and never touched it. Today, 25 years later, the account value is over $10,000. Over the years I was able to watch the investment value grow, and watch the stream of dividends increase slowly but consistently over time.

Some years the fund’s value would drop, while other years the fund would perform very well. While still a kid, I had the opportunity to observe the market in action and watch my own investment grow. What a great way to learn about the market!

Disclosure: I hold shares of all securities mentioned in this article through index fund investments.