Best Broker For a Custodial IRA For Your Kids

The age of majority is 18 in most states in the U.S. Kids under 18 are allowed to work for pay but they aren’t allowed to open an account with a financial institution unless an adult over 18 is either a joint owner or a custodian. This is because kids under 18 can’t legally sign a contract and agree to the terms.

When a kid works for pay, a parent can open a Roth IRA for the kid and fund the Roth IRA with the parent’s money, up to the kid’s earned income. However, an IRA by definition has only one owner; there’s no joint IRA. Because the kid under 18 can’t open the account him- or herself, an adult has to do it as the custodian.

This type of account is called a custodial IRA. The kid is the owner. The adult is the custodian.

A custodial IRA is different from a UGMA/UTMA account. A custodial IRA is tax free if you choose the  Roth flavor. A UGMA/UTMA account is still taxable. But funding a custodial IRA is limited to the kid’s earned income; a UGMA/UTMA account doesn’t have such requirement.

Not all places offer a custodial IRA. For instance Fidelity will not open an IRA unless the owner is at least 18. Maybe the market is too small. Many kids work but their parents aren’t willing to fund a Roth IRA for the kids when the parents themselves don’t save enough for their own retirement.

If you find a place that offers a custodial IRA, the next hurdle is the minimum amount required for opening an IRA and the fees charged on small accounts. The kid’s earned income may be very small. That’s another reason financial institutions aren’t that interested in this type of accounts.

Vanguard offers a custodial IRA but the minimum amount required to open one is $1,000.

Fortunately some places have a long-term view. They make it easy for kids and their parents because they understand a relationship entered into when the kids are young will likely last when the kids become adults.

Charles Schwab, for example, offers a custodial IRA with a $100 minimum and no maintenance fees. You can invest in low cost Schwab index funds which require only $100 minimum and no purchase fees. A kid’s IRA at Schwab can have a diversified portfolio with very little money.

If your kids work, seize the opportunity to open a custodial Roth IRA for them.

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  1. Doug Nordman ("Nords") says

    I’m glad to see that this is getting easier for parents. A teen’s IRA is one of the most powerful forms of compounding that an investor can find.

    Back in early 2007, the only place we could find that welcomed custodial IRAs with a low minimum was T. Rowe Price. Even their funds were expensive. As soon as our daughter turned 18, we moved on over to Fidelity.

    I think the fund companies are short-sighted and putting a higher priority on 401(k)s instead of IRAs. They’re not willing to subsidize a young investor through high school and college, when the majority of them will finally have enough income to resume funding their IRAs. Yet if the companies snagged them during their susceptible teen years, their customers would likely stay loyal for decades…

  2. Peter Baldwin says

    I have two great grand sons; both under age of five years. Would like to establish education funds whereby my initial contributions and subsequent earnings will eventually be available tax free. Should this be in the boys natural parents names?
    Also could parents control funds distribution when boys reach college age?

    Any comments will be appreciated.

    Thanks, peter baldwin

    • Harry Sit says

      Peter – The subject of this article — a custodial IRA — is for employment income earned by the child, such as from a summer job. It’s not for money you contribute for their education. You can look into a 529 plan, in your name or the parent’s name, with the child as the beneficiary.

  3. Ian Marshall says

    Peter, the accounts, if they were Roths, would have to be in the kids names. 529’s are in the name of whomever set them up. That person then designates beneficiaries. Also, with Roth’s, those kids would have to earn taxable income in order for you to gift them the equivalent into each of their Roths. Harry is correct that the 529 is designed for what you’re inquiring about. But in many ways the Roth is a far more versatile avenue for saving. You can contribute more, and at a younger age, in a 529, but the money is earmarked solely for educational use… and computer technologies. The Roth can be used as either educational savings, or a down payment for a home without penalty… or retirement for which it was intended. You’re just limited to 5,500 per child, and that’s provided they earned 5,500 or more that year… challenging for a 7 year old. Think 14 or 15 year olds. If you could find a way to create taxable income for 10 year olds, you could create a great avenue for saving for college and generating long term compounding tax-free wealth. And despite Roth’s traditionally not being pretax dollars, they would be in this scenario because the kids most likely aren’t earning enough income to pay taxes. Another thing, FAFSA looks at 529’s when deciding the student/parent contributions for college. They don’t look at Roth’s. So it is a shelter for lack of a better term, and the children would possibly qualify for more grants, loans… Etc. I understand that the goal is to avoid loans. Roth’s just give you choices… Take the loan keep the tax-free wealth machine, or liquidate the Roth and avoid the loan… Choice.

  4. Andrea says

    If a child’s income is paid in cash, how do you determine the amount allowed to contribute? Does it affect the requirement for the child to file a tax return, even if under the amount where they would have to file a return?

    • Harry Sit says

      Andrea – Income is income regardless how it’s paid. If you end up filing a return even when it’s not strictly required, it’s not necessarily a bad thing. A simple return is simple.

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