Should we set up an investment fund for our 3-year-old or just donate later from our own?

We’re thinking about setting up a custodial account for our 3-year-old as a way to give him a head start in life. It could help with something like a down payment later on (we already have a 529 plan for his education).

It seems like starting early has a couple of benefits:

  • The money is fully committed to him, so there’s no temptation to use it for something else.
  • Compounding interest over the years could make the gift much more impactful later.

Of course, he’ll have to deal with long-term capital gains tax when the time comes, but that’s part of the deal.

Any pros or cons we should consider?

  1. Yes, it locks the money in for the child, but it also means it’s fully theirs. If they end up being irresponsible or have bad habits, that money could enable them.

  2. The lifetime gift tax limit is $13M—are you anywhere close to hitting that?

Custodial accounts often don’t make much sense. It’s usually better to save the money yourself and decide when and how to give it later.

@Axel
What I did was open an account in my name and nicknamed it for my child. When they’ve proven they’re responsible, like graduating college or living independently for a while, I’ll give them the money.

@Axel
Good point about the gift tax—it’s not really a concern for us. You’re right that we can’t predict how responsible he’ll be. Maybe we’ll start with a small account he can manage as he grows and hold off on a larger one until later.

@Fane
We’re planning to set up a small account for our kids too, so they can learn to invest hands-on.

@Fane
Don’t forget, you can gift $15K per parent per year without touching the gift tax exemption. That’s $30K per year total.

Briar said:
@Fane
Don’t forget, you can gift $15K per parent per year without touching the gift tax exemption. That’s $30K per year total.

Actually, the limit is increasing to $19K in 2025.

@Winter
Thanks for the update! I hadn’t been keeping track.

@Fane
Have you heard of Stock Slices? It lets you buy fractional shares. I’m considering it for my kids to help them learn about investing. I think Charles Schwab offers it.

Patton said:
@Fane
Have you heard of Stock Slices? It lets you buy fractional shares. I’m considering it for my kids to help them learn about investing. I think Charles Schwab offers it.

Fidelity might be a better choice for fractional shares. They let you invest in thousands of companies, while Schwab limits you to S&P 500 stocks.

You could also look into setting up a trust. With a trust, you can decide when and how the money gets used. Custodial accounts require you to hand over control at a specific age, but a trust gives you more flexibility.

Here are links to some options:

Personally, I’d skip the education fund and just set up a general investment account for the kids. They could use it for anything—college, a house, a wedding—whatever they need most at the time.

Kelly said:
Personally, I’d skip the education fund and just set up a general investment account for the kids. They could use it for anything—college, a house, a wedding—whatever they need most at the time.

We’re planning to put at least $100K into a 529 for the tax advantages. If he doesn’t use it for college, we’ll pay a penalty, but I think it’s worth the risk since the odds are good he’ll pursue higher education.

@Fane
Don’t forget, you can roll over up to $35K from a 529 into a Roth IRA for your child after 15 years. It’s another reason to stick with the 529.

If the investment income stays under $2,500, there are tax perks: no tax on the first $1,250 and a lower rate on the next $1,250. Above $2,500, it gets taxed at the regular rate.

You could also consider a mix of a custodial investment account and a custodial IRA.

The main downside of custodial accounts is you have to hand the money over to the child at a specific age—usually 18 or 21, though some states allow up to 25. For small gifts, I think it’s fine, but for significant amounts, I’d consider a trust instead.