How a gift of money can help build investing habits

A dad carries his daughter on his shoulders

Check out two ideas to help children gain early investing experience for a financial head start.

As a parent or grandparent, you likely want to teach children sound money habits and to help them become financially successful adults.

There are a variety of ways to instill good financial habits. The following two approaches allow you to gift assets to children while providing them with hands-on investment experience that may prove useful in the future.

1. Custodial accounts

Custodial accounts can be opened for your children before they turn 18. They can be a useful vehicle to teach children about the principles of money and investing.

With these accounts, custodians control how investments are managed. Sharing account statements and the way you make decisions on your children’s behalf can be an opportunity to teach smart investment principles.

There are a couple of considerations you will want to think about as you determine whether such an approach is right for you and your family. First, when funding these accounts, keep in mind that control of these accounts transfers to the child when the custodianship ends. This generally happens when the child reaches age 18, 19 or 21, depending on state law. You may not want your child to have control of more financial assets than they can handle at that age.

It is also important to know that special tax rules, the “kiddie tax” rules, may also apply. The income or capital gains generated in these accounts could be taxed at trust income tax rates for children under age 19 (age 24 if a full-time student). This means your young child may have to file an income tax return of their own, and the tax bill could be higher than if you held the assets in your own name. Your tax advisor can help you determine how these rules would apply to your situation.

2. Gifting money in an IRA (Individual Retirement Account)

Helping fund an IRA can benefit adult children who are starting their career and can’t afford to contribute to a retirement account or don’t have a workplace retirement plan. Even teens with earned income can fund an IRA.

The earlier your children start investing for retirement, the more their investments may accumulate over time. There are two types of IRA, a Traditional IRA and a Roth IRA.

  • Traditional IRA: If eligible, your child may receive a tax deduction when they contribute to a Traditional IRA, which will also offer tax-deferred growth potential. Any earnings from the account may grow tax free until the money is finally distributed.
  • Roth IRA: This type of account is not eligible for tax relief on the contributions, but any earnings could be distributed tax-free if taken after the Roth has been opened for more than five years and your child is aged 59½ or older. In addition, your child may be able to tap into these funds if they need them due to a disability or for use in purchasing their first home.

If you are thinking of gifting money, be sure to talk to a tax professional. Any time you give money to a child—including to a custodial account or an IRA—IRS gift rules apply. In 2022, an individual may gift up to $16,000 annually (or $32,000 per married couple) to each family member without it being counted as a reportable gift for gift tax purposes. Those gifts don’t count against your lifetime gift tax exclusion.

Wells Fargo Advisors does not provide tax or legal advice. Please consult your tax and legal advisors to determine how this information may apply to your own situation.