So you have decided to set some money aside for a minor? Or maybe you already saved some money and are now looking to put that into a new Custodial Account. Robinhood is a fairly new platform that has gained much traction in recent years. The Robinhood app is especially popular because of its ease of use. Robinhood supports many different account types, such as a Roth IRA Account. But how do you open a Custodial Account for a Minor on Robinhood? In this blog post, we will look at that question and your available options.
A Custodial Account is a great way to save and grow money for your child or grandchild. The moment they become old enough, they get access to the account. It can provide them with a very good headstart early in their life and set them up for financial success.
Let’s look at custodial accounts, requirements, limitations, and more.
What is a Custodial Account?
Simply put, a Custodial Account allows you to transfer money, financial securities, real estate, and more to a minor. You can manage and grow the investment on behalf of a child until they reach a specified age (18 to 21 years). These investments are partially tax exempted from federal taxes. Custodial accounts are financial products governed by the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). That’s why they are sometimes referred to as UGMA accounts or UTMA accounts.
Custodial Accounts are the best way to set a minor up for financial success. They can provide a great amount of financial security.
Usually, they are opened by a family member, but you don’t need to be part of the family to open a custodial account for a minor. Once an account is opened, all family members and friends can contribute money, but only you make the investment decisions as the custodian.
How can you prepare a Minor for a Custodial Account?
Opening a custodial account for a minor can be a life-changing decision. If you open them very early in their life, the money has a long way to go and can grow exponentially. However, for the minor to suddenly become the owner of a large portfolio can be scary. At that moment, they become a young investor after all. But you can do more than save money in the years leading up to the ownership transfer. If you include the child in the process, you can help them create healthy money habits. Here are some helpful tips on how you can make the child take part in the journey.
- Awareness of Part-Ownership – If you invest in individual stocks, let them pick companies they like. Make them part of the investment decisions. For example, if they like Disney, teach them about the company. When you visit Disneyland, talk about being a proud part-owner of the company. Whenever there is time and an opportunity to raise awareness, take it and talk about it.
- Talk about Risk – Use real-world events that affect the portfolio to talk about risks involved with investing. Teach them about being patient while investing. Revisit the portfolio performance and the performance of the individual stocks on a regular basis.
- Portfolio Diversity – Talk about investing in multiple different companies to mitigate risk. Every sector is different and carries a variety of risks.
- Look closer at Companies – Once the child is older, you can take closer looks at companies together. Read about the company’s mission statement, investor relations, news, or anything that helps research a company.
- Compounding Returns – The power of compounding returns is hard to understand for all of us. Teach your child about this power by calculating and updating the projected balance of their account. Assume reasonable growth and contribution rate. The longer the investment can grow, the bigger the compounding returns are.
- Continue Investing – The investment journey of the child is just beginning. You should more and more encourage them to continue investing on their own once they come of age. Read more about that mindset in my article, “Journey into the Art of Long-Term Investing“
You need to gauge when the time is right for all these topics. The child might not be interested in the early age. Every child is different, and it is important for you to listen to them. Your biggest task is teaching how to be responsible with money.
Differences to Savings Accounts and 529 Accounts
In contrast to a savings account (or a checking account/any bank account for that matter), you can leverage the wealth-generating potential of the stock market. Once the minor assumes ownership of the account, he can spend the money on anything. This also differs from 529 Accounts, where the funds can only be spent on educational expenses. So, there aren’t really any limitations on how the money can be used eventually. This makes Custodial Accounts very flexible and a great option to consider.
Another difference to 529 Accounts is contribution limits. You don’t have a contribution limit on a Custodial Account. However, you may have to pay gift taxes if you gift more than $15,000 (or $30,000 as a couple) in one year to one account.
When you invest in a custodial account, all transactions are made on behalf and in the name of the minor. This means that any gains are also taxed at the minor’s tax rate, which is usually much lower. This is a huge benefit for your own income tax. Read more about tax optimizations in my article “How To Avoid Paying Capital Gains Taxes On Stocks.”
Who can use the Money from the Custodial Account?
All the money you or any other person puts into the Custodial Account becomes irrevocably owned by the child. You have no way of taking out any money for your personal use. There is one exception, however. You can take out money used for the direct benefit of the minor itself. Examples are school supplies. You need to keep in mind that taking out money creates taxable gains for your child. You will also miss out on any future growth of that money.
What are your Investment Options
A Custodial Account is very similar to a regular brokerage account. You can invest in stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Basically, anything you can do with your regular brokerage account, you can also do in a Custodial Account.
If you are a new investor, your best investment option is likely a broad index, like the S&P 500. Such an index gives you exposure to all sectors and industries in the entire economy. It is less volatile and has a yearly historical return of approximately 9.8%. You can consult a financial advisor anytime if you need more help.
How to Open Custodial Account for Minor on Robinhood?
Robinhood allows several different types of accounts. Unfortunately, a Custodial Account is still not one of them. For opening a Custodial Account, you will have to look for a different brokerage firm, such as:
Different brokerage firms have different rules and fee structures. Make sure you understand these before opening a custodial account. For M1 Finance, I have an interesting post, “M1 Finance Review (and how I use it).”
You might think of opening a regular Robinhood Account for the minor, but that is also impossible. Even if possible, you would lose a lot of benefits of a custodial account, such as tax advantages. But Robinhood requires the account owner to have a minimum of 18 years of age.
Do you like Robinhood and want to get the most out of it? Take a look at our other articles about Robinhood:
- Do You Have To Report Stocks on Taxes With Robinhood?
- How To Pay Your Tax On Robinhood Stocks – Investor Guide
- Can You Link and Transfer Money from Paypal To Robinhood
- How To Reinvest Dividends On Robinhood – Investors Guide
- How do you disable Margin on your Robinhood Account
- When Does Robinhood Send 1099 Tax Documents To You?
Final Thoughts – How to Open Custodial Account for Minor on Robinhood
Robinhood does, at this time, not offer a custodial account option. However, there are many other brokerage firms out there that do offer such a type of account. Look at account fees, trading fees, and trading commissions to find the best custodial account.
In this blood post, you have learned about custodial accounts and their benefits. We also discussed interesting strategies to include the child in the investment journey and prepare them for the ownership transfer of the custodial account. Once they are in control of the account, they will know how to manage it responsibly. Investing can be a fun exercise for the minor. It can teach them valuable lessons for their life.
A custodial account is a very good option to prepare a child for financial success. There are many important lessons you can teach the child along the way. And even if you are a novice investor, you can learn about investing for yourself and start with a broad index. You can’t make any mistake with such a simple strategy.