How to Invest for Your Kids: 529s, Custodial Accounts, and Roth IRAs

If you want to invest money for your child, you have three main account types to choose from, and the right one depends on what the money is for. A 529 plan is built for education and grows tax-free when used for school. A custodial account under UTMA or UGMA is a general-purpose investment account the child legally owns and takes control of at 18 or 21. A custodial Roth IRA lets a child who has earned income start retirement savings decades early. Learning how to invest for your kids starts with picking the account that matches the goal, because the tax rules, contribution limits, and strings attached are very different for each one.

Minors can’t open any of these accounts themselves; they lack the legal capacity to enter a binding financial contract, so a parent or guardian opens and manages the account on the child’s behalf.

What You Need to Open the Account

Every investment account opened for a child requires the child’s Social Security number, because federal tax law requires an identifying number on any account that generates taxable income.¹ If your child doesn’t have one yet, apply through the Social Security Administration first.

You’ll also need your own government-issued photo ID and proof of current address, such as a utility bill or lease. Financial institutions verify the identity of everyone opening an account under rules set by the USA PATRIOT Act.² The application asks for the child’s full legal name, date of birth, and your relationship to the child. Most major brokerages let you complete everything online in about 15 minutes.

529 Plans for Education

A 529 plan is the most popular way to invest for a child’s education. The money grows tax-free and comes out tax-free as long as you spend it on qualified education expenses.³ Unlike a custodial account, you keep full control of the money even after your child turns 18, and you can change the beneficiary to another family member if your child doesn’t need the funds.

What Counts as a Qualified Expense

For college, qualified expenses include tuition, fees, books, supplies, room and board (for students enrolled at least half-time), and computers or internet access used during enrollment. Since 2018, you can also use up to $10,000 per year for tuition at elementary or secondary public, private, or religious schools.⁴ The K-12 allowance covers tuition only, not books or supplies.

What Happens if the Money Isn’t Used for School

Non-qualified withdrawals trigger ordinary income tax on the earnings portion, plus an additional 10% federal tax penalty on those earnings.³ Your original contributions come out penalty-free since that money was already taxed on the way in. The 10% penalty is waived if the beneficiary receives a scholarship (up to the scholarship amount), becomes disabled, or dies.

A newer safety valve helps with the overfunding worry. Starting in 2024, unused 529 funds can be rolled over into a Roth IRA in the beneficiary’s name. The lifetime cap is $35,000, each year’s rollover can’t exceed that year’s IRA contribution limit ($7,500 for 2026), the 529 account must have been open for at least 15 years, and the specific funds being rolled over must have been in the 529 for at least five years.

Contribution Limits and Gift Tax

There’s no federal annual contribution cap on 529 plans. Each state sets a lifetime account balance limit, typically between about $235,000 and over $620,000 per beneficiary.

For gift tax, contributions count as gifts to the beneficiary. You can contribute up to $19,000 per beneficiary in 2026 without filing a gift tax return.⁵ A “superfunding” election lets you front-load five years of gifts at once: up to $95,000 in a single year from one person, or $190,000 from a married couple, reported on IRS Form 709 and spread across five tax years. You can’t make additional gifts to that beneficiary during the five-year period without exceeding the annual exclusion.

More than 30 states and the District of Columbia also offer a state income tax deduction or credit for 529 contributions. Amounts range from around $1,000 to unlimited, and most states require you to use their in-state plan to claim the benefit.

Custodial Accounts (UTMA and UGMA) for General Investing

Custodial accounts under the Uniform Transfers to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA) work differently from 529 plans. Once you put money or assets in, the gift is irrevocable and belongs to the child.⁶ You manage the investments as custodian, but the child legally owns every dollar.

The big advantage is flexibility: there’s no restriction on what the money can eventually be used for. The big disadvantage is that you lose all control when your child reaches the age of majority, which is 18 or 21 depending on the state.⁶ At that point, the money is theirs to spend however they choose, with no mechanism to extend your control or reclaim the funds. If you’re uncomfortable with an 18-year-old having unrestricted access to a significant sum, a 529 plan or a trust may be a better fit.

While you’re managing the account, you can spend the money for the child’s benefit, but that phrase is narrower than it sounds. Courts have consistently held that custodial funds cannot be used for expenses you’re already obligated to provide as a parent, like food, clothing, and shelter. Custodial funds should only cover things beyond your normal parental obligations, or be tapped when your own resources are genuinely insufficient.

Which form of custodial account you use depends on state law. UGMA accounts are limited to financial assets like cash, stocks, and bonds. UTMA accounts can also hold real estate, patents, and other property. Most states have adopted UTMA, and it’s the default at major brokerages.

Custodial Roth IRAs for Early Retirement Savings

A custodial Roth IRA lets a child start building tax-free retirement savings decades earlier than most people. The catch is the child must have earned income from a job or self-employment. Allowance, gift money, and investment returns don’t qualify.

The 2026 contribution limit is $7,500, or the child’s total earned income for the year, whichever is less.⁷ If your teenager earns $3,000 from a summer job, the maximum Roth contribution for that year is $3,000. A parent or grandparent can make the actual deposit as long as the child earned at least that much.⁸

Documenting a Child’s Earned Income

W-2 jobs are straightforward. Self-employment income from babysitting, lawn care, or freelance work takes more care. Keep a simple log of work performed, dates, and payments received, and use payment apps that create transaction records when you can. Filing a tax return for the child each year a Roth contribution is made is strongly recommended even when the income falls below the normal filing threshold. A minor with net self-employment earnings of $400 or more is required to file and pay self-employment tax regardless of any Roth contribution.

The earnings have to reflect real work at reasonable rates. Overstating a child’s income to maximize Roth contributions can trigger penalties and undo the contribution.

The Kiddie Tax on Investment Income

Any time a child earns investment income from dividends, interest, or capital gains in a custodial account, the kiddie tax rules decide how it’s taxed. For 2026:⁹

The first $1,350 is tax-free, covered by the child’s standard deduction for unearned income.
The next $1,350 is taxed at the child’s own rate, typically 10%.
Anything above $2,700 is taxed at the parent’s marginal rate, which can be as high as 37%.

The kiddie tax applies to children under 18, children who are 18 with earned income that doesn’t exceed half their support, and full-time students ages 19 through 23 whose earned income doesn’t cover half their support.⁹ If the child’s income is only from interest and dividends and the total is less than $13,500, you can elect to report it on your own return using Form 8814 instead of filing a separate return for the child.

This is the main reason large custodial accounts aren’t always the tax-friendly strategy they look like. A child sitting on a $100,000 UTMA throwing off $4,000 a year in dividends will owe tax at the parent’s rate on a meaningful chunk of it. Earnings inside a 529 plan or Roth IRA grow tax-free as long as the withdrawal rules are followed.

How Each Account Affects Financial Aid

If your child will apply for federal financial aid, account type matters. The FAFSA formula treats student-owned assets much more harshly than parent-owned assets.

UTMA and UGMA accounts are considered the student’s property. Under the current Student Aid Index formula, 20% of a student’s assets are expected to go toward college each year.¹⁰ A $50,000 UTMA account reduces aid eligibility by roughly $10,000 per year.

A 529 plan owned by a parent is counted as a parent asset, assessed at 12% of net worth above a protection allowance, which is a lower effective hit than the flat 20% on student assets.¹⁰ A 529 plan owned by a grandparent or other third party is not reported as a FAFSA asset at all under current rules, making grandparent-owned plans one of the most aid-friendly ways to save.

Custodial Roth IRAs are not reported as assets on the FAFSA, and qualified withdrawals aren’t counted as student income. The earned income requirement caps how much can go in, but for families expecting to apply for aid, that profile is hard to beat.

Funding the Account and Choosing Investments

Once the account is open, you’ll link an external bank account using your routing and account numbers. Most brokerages verify the link by sending two small test deposits and asking you to confirm the amounts. Transfers typically take two to five business days to settle before the money is available to invest.

Minimum balance requirements vary. Many major platforms have eliminated minimums entirely; others require up to $500. Setting up automatic recurring transfers, even modest ones, is one of the most effective ways to build a child’s account. A $100 monthly contribution invested over 18 years at a 7% average annual return grows to roughly $43,000, more than double the $21,600 you’d put in.

For 529 plans, you’ll usually pick from a menu of age-based or static portfolios offered by the plan. Age-based options automatically shift from stocks toward bonds as college approaches. Custodial accounts and custodial Roth IRAs at most brokerages give you the full range of stocks, bonds, mutual funds, and ETFs. Low-cost index funds are hard to beat for an account the child won’t touch for a decade or more.

1
Office of the Law Revision Counsel. 26 USC 6109 – Identifying Numbers
2
Financial Crimes Enforcement Network. USA PATRIOT Act
3
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
4
Internal Revenue Service. 529 Plans – Questions and Answers
5
Internal Revenue Service. Whats New – Estate and Gift Tax
6
HelpWithMyBank.gov. Uniform Gifts to Minors Account (UGMA)
7
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
8
Internal Revenue Service. Retirement Topics – IRA Contribution Limits
9
Internal Revenue Service. Topic No. 553, Tax on a Childs Investment and Other Unearned Income
10
Federal Student Aid. Student Aid Index (SAI) and Pell Grant Eligibility