Getting Kids Started with the Stock Market

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Recently, a reader asked how to give stock to kids in her life in an effort to inspire a life-long interest in investing. Now seems like a great time to start investing but opening an account for someone who isn't your child (a nephew or niece, for example) isn't as straightforward as handing over cash.

The investments may cause a burden on the child or the family members. Here's why:

• There may be fees associated with the account, such as annual maintenance fees and transaction costs.
• Account owners may owe income taxes on dividends and stock sales.
• The account value will likely impact the financial aid status of the child (though the investments should be useful in paying for educational expenses).

Ideally, you can open an account with low or no fees and the account will be structured in a way that minimizes the tax consequences. Issues to consider in addition to fees, taxes, and financial aid: 

• ownership and control of the account (usually the parent or legal guardian controls the account as its custodian)
• methods of making additional contributions (purchasing additional shares of stock or mutual funds)
• type of investment: individual stocks and/or mutual funds
• tax structure of the account: college savings account (such as a 529 plan or Coverdell ESA-Educational Savings Account), Roth or Traditional IRA (kids can have these types of accounts but need earned income to qualify for funding the account), and regular/custodial account that will be taxed at the child's tax rate, usually lower than the parent's rate.

Finally, the tricky thing about opening an account for someone else is that typically you'll need the Social Security Number (SSN) of the child and/or the custodian. Privacy concerns, even among friends and family, may cause well-intentioned gift-givers and recipients to shy away from starting an investment account or allowing another person to open the account.

Still, there are ways to get kids started with investing. Consider these methods:  

1) Get things ready to start directly investing in shares of a chosen company using a DRIP-Dividend Reinvestment Plan, generally a low-cost option

• Choose a company with a DRIP (see explanation of DRIP) or Direct Investment Program. Companies that have these plans include Target, Best Buy, Lowe's, Home Depot, Nike, Disney, Harley Davidson, Pepsico, Procter & Gamble, and 3M.
• Compare plan options at DRIP Advice or do your own research of start-up fees, minimum investment amounts, maintenance fees, etc.
• Request or download and print enrollment forms.
• Get some tangible item that represents the company: order the annual report (or download and print one), a logoed shopping bag, store gift card, or a company product (Nike shoes) for example.
• Write a check to fund the account opening and initial purchase of shares. You can write a check to the child or the parent; or give cash.
• Put everything together in a nicely wrapped package (your gift and paperwork). 
• Let the parent or legal guardian take care of opening the account.

2) Transfer funds from your account to the child's account

• You'll need to start by owning some investments that you think will be worthwhile to transfer to someone else. Presumably, if you are interested in helping a young person learn about the stock market, you've acquired some investing experience and hold some sort of investments that can be transferred. However, you may want to start learning yourself and you can acquire stock now to be transferred later. 
  
• Initiate a transfer.
• Tell the child recipient about the gift / transfer and pass along accompanying paperwork.
• Let the child and parents open an account to receive the stock.

Using approaches 1 and 2, you can avoid having access to the child's Social Security Number, so that the parent doesn't need to feel uncomfortable about sharing personal information.

3) Open a 529 Plan for college savings

• Choose a 529 Plan offered through your state, another state, or an independent group for participating private schools. Typically, you'll choose from a menu of plans that invest in mutual funds and bonds, rather than selecting individual stocks.
• Sign up for the plan as the account owner and designate the child to whom you want to make a gift as the beneficiary.
• Make a contribution to the plan to open the account and then make periodic contributions, such as a gift for birthdays and special occasions.
• Create a memorable gift by wrapping a savings bank or some item that represents higher education (a t-shirt or sweatshirt of a favorite college) with an accompanying mention of the contribution (or, if the child is old enough, copies of the plan statement).
• Keep in mind that funds in the 529 plan need to pay for qualified educational expenses and you can change the beneficiary (though that would negate the value and intent of the gifts over the years).
• The child will get a general idea of how investing works but won't be able to make decisions about the investment beyond choosing various plans, similar to the selection of a 401(k) plan; also the child probably shouldn't contribute to the account as he/she is not the owner and the beneficiary can easily be changed.

4) Try these options

• Open an account with a mutual funds company, such as Vanguard or Janus. Initial minimum investment is high: $3,000 for Vanguard and $1,000 for Janus (or just $500 with Janus if you make automatic investments). Both companies offer various account types such as Custodial Accounts for Minors and Coverdell ESAs. Investments will be in mutual funds rather than individual stocks.
• Open an account with an online brokerage company such as E*Trade or TD Ameritrade.  Account requirements vary but you can get started with a nominal investment amount and avoid maintenance and transaction fees. You can invest in stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
• Open an account with ShareBuilder, which has minimal account fees depending on the plan. You can start a Coverdell ESA or Custodial Account. (See this post for a comparison of ShareBuilder vs. Online (Discount) Brokerage Company.)
• Buy a share and stock certificate from Oneshare. This option seems cool as the gift includes a framed stock certificate and start-up guide, but is the most expensive approach. The process looks simple but you'll still need the child's SSN for a gift.

To help guide your decision, talk with your CPA, financial advisor, plan administrator, etc. and whoever may be responsible for keeping up with the investment.

Have you had great success (or unintended consequences) in starting an investment account for a child? Share your experiences in the comments.