Sudarshan Sridharan is a North Carolina high school student who scored headlines recently… not for winning a football championship or starring in the school play, but for making $17,000 by betting on Tesla. That’s right: While most teens daydream about owning one of these cool cars, he went ahead and bought the stock.
But that $17,000 wasn’t the only big win for Sudarshan. He also made $14,600 on Google and $5,600 on Netflix. All of his gains were made within a three-year time period.
OK, so by now you’re ready to get into the stock market too, right? That’s awesome — even with modest gains, you’ll be getting a big jump on where you’ll need to be financially when you’re an adult. By starting to invest now, you’ll be able to build an incredible large investment portfolio a lot sooner than you think.
However, before you start calling up the stock brokers we review here at Investor Junkie, be aware that there’s one basic but sucky problem with being a teenage investor: You can’t open your own brokerage account.
There are a lot of investing apps that look perfect for teenagers (hello, Robinhood), but you still need to be at least 18 years old to participate. This is a legal requirement specific to the investment industry, and there’s really no way around it.
At least, not directly.
Here’s what Sudarshan did: He invested using a custodial account that was opened and maintained by his dad.
These accounts let you invest through an adult. When you are 18 or 21 years old (depending on your state’s laws), the account will revert to your name. By then, you’ll be all set to fly solo.
So let’s talk about custodial accounts.
How Custodial Accounts Work
Basically, a parent or guardian opens a custodial account for you and then “gifts” funds into it. For 2018, up to $15,000 can be gifted each year into a custodial account.
Once the funds are in the account, you can begin investing the money. Of course, your parent or guardian will have to make the actual trades for you. They will retain management control over the account, and as a teenager, you aren’t allowed to contact the account broker to execute your trades.
However, you can definitely be part of the investment process. You can create a portfolio allocation and select asset classes and even specific investments.
Once you reach legal age in your state, the account’s ownership will convert to you. With the experience that you hopefully gained through the custodial arrangement, you should be fully able to manage the account going forward.
What About Taxes?
Your account will not be tax exempt. But it will be taxed at your own tax rate. This is usually a good thing, since you’ll probably have a much lower rate than your parents.
Here’s the tax liability if you’re under 19 years of age:
- The first $1,050 of investment income is tax free.
- The next $1,050 is taxed at 10%.
- Any income in excess of $2,100 is taxed at your parent’s marginal tax rate, which could be as high as 37%. This is what is often referred to as the “kiddie tax” (eyeroll).
The Best Custodial Accounts
Here at Investor Junkie, we’ve reviewed a number of services that offer custodial trading accounts. And we’ve found some products that are pretty cool.
For example, check out Stockpile. This online brokerage was actually founded because its CEO wanted to give his nieces and nephews stocks for Christmas. Your friends and family can buy you gift cards that are then used to purchase stock for you in a custodial account.
Stockpile lets you buy fractional shares of big-name companies like Apple and Netflix. That means you can buy, say, just $50 worth of the company behind Stranger Things, rather than putting out more than $300 for a full share.
You can also invest small amounts into an investing account thanks to microsavings service Stash. Stash recently started offering custodial account, and this is a great way to get started.
With this service, young people can invest as little as $5 in exchange-traded funds (ETFs) or a growing list of single stocks, including Facebook and the Walt Disney Co. It’s all done from a mobile phone, so it’s super easy and convenient.
- Minimum Investment: $5
- Fees: First month FREE; $1/month under $5k; 0.25%/year over $5k
- Website Access: Yes
Custodial Traditional IRAs
If you’re investing for the long game (and thanks to compound interest, this is an awesome time to start), you can actually get an individual retirement account set up. These are known as IRAs, and not many people know that you can get one of these when you’re a teenager.
Compound interest is like a gift that keeps on giving. Over time, it lets your money snowball and accumulate. Let’s say you contribute $5,500 per year to a traditional IRA at ages 15, 16 and 17. You’ll have $16,500 in the account. Now let’s say you make no further contributions for the rest of your life.
You could have $773,877 by age 67, the expected age of full retirement, if the account has an average rate of return of 8% per year for the next 50 years.
The only requirement is that you earn income that you can contribute to the account. For 2018, a teenager can contribute up to $5,500 of their earnings each year to a traditional IRA.
The investment earnings in your IRA will accumulate on a tax-deferred basis. But there are some benefits before you reach retirement age. For example, you can make a penalty-free withdrawal to buy your first home.
Custodial Roth IRAs
You can also set up a custodial Roth IRA as a teenager. These work much the same as a traditional IRA. You can make annual contributions up to $5,500.
But there are differences between a traditional and Roth IRA. The first is that a Roth contribution is not tax deductible. Perhaps the biggest difference is that the distributions from your account will be tax-free.
There’s another big difference between the two plans, one that will be a major benefit for teenagers. With a Roth IRA, after five years, you can withdraw your contributions at any time, free from both regular income tax and the 10% early withdrawal penalty. This is because you already paid tax on them.
After you have fully withdrawn your contributions and begin withdrawing accumulated investment earnings, income tax and penalties will apply. This is referred to as Roth IRA ordering rules.
The Roth IRA lets you get the benefits of tax-deferred investment income and building a retirement plan, but funds can be withdrawn early if necessary. That will be especially important in the life of a young person and might make a Roth IRA preferred over a traditional one.
Investment companies that offer custodial traditional IRAs usually offer custodial Roth IRAs as well.
Custodial IRAs Revert to the Teenager Upon Reaching Legal Age
While the teenager is considered a minor, the IRA account is in the name of the parent or guardian. But upon reaching age 18 or 21, depending on where you live, account ownership converts to the teenager.
If you start your account at age 14, you’ll have four years’ investment experience by the time you’re 18. At that point, you should be ready to take over the account and make all the investment decisions.
You’ll likely also be more investment savvy than your peers, who probably have no investment experience at all. Plus, you’ll have the benefit of a growing investment account to build on throughout life. It’s really one of the best starts you can have.
Investment brokers that offer custodial IRAs include the following:
The team at Investor Junkie likes E*TRADE in particular for beginning investors.
- Minimum Investment: $500
- Stock Trades: $6.95/trade
- Options Trades: $6.95/trade
Unfortunately, robo advisors typically don’t offer custodial IRAs. That’s too bad, because these robo-investing platforms could be the perfect IRA choice for teenagers, though not necessarily the best learning tool for investment purposes.
No matter, you can begin by opening a custodial IRA through one of the brokers above. Then, when you reach legal age, you can transfer the account to a robo advisor if you want.
The Bottom Line
If you want to be a teenage investor — and you absolutely should if you can — ask your parent or guardian to set up a custodial investment account. You’ll have time to learn the investment ropes and build up a small portfolio. That will give you a head start when you reach adulthood.
Trust me, it will be better than getting a new car as a graduation present.