Index Funds for Kids: How to Invest for Your Children's Future

Why Invest for Your Children Early?

Compound interest is most powerful over the longest time horizons. A child born today has potentially 65+ years for investments to grow before traditional retirement age. Starting early — even with modest amounts — can result in extraordinary wealth by the time they're adults.

Option 1: Custodial Account (UGMA/UTMA)

A custodial account — established under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) — is a taxable brokerage account opened in a child's name and managed by an adult until the child reaches adulthood (18 or 21, depending on the state).

Key features:

• No contribution limits (though gifts above $18,000/year may trigger gift tax)
• Anyone can contribute — parents, grandparents, relatives
• Child gains full control at adulthood
• Flexible — money can be used for anything, not just education
• Subject to capital gains taxes ("kiddie tax" rules apply)

Best brokerages for custodial accounts: Fidelity, Vanguard, and Charles Schwab all offer excellent custodial accounts with access to low-cost index funds.

Option 2: 529 Education Savings Plan

A 529 plan is a tax-advantaged account specifically designed for education expenses. Contributions grow tax-free and withdrawals for qualified education expenses are completely tax-free.

• Advantage: Tax-free growth and withdrawals for education
• Disadvantage: Non-education withdrawals face taxes plus a 10% penalty
• Recent change: As of 2024, unused 529 funds can be rolled into a Roth IRA (up to $35,000 lifetime limit), making them more flexible than before

Option 3: Roth IRA for Teens with Earned Income

Once a child has earned income (from a job, babysitting, or other work), they can contribute to a Roth IRA — up to the amount they earned or $7,000, whichever is less. A parent can "gift" the money to fund it as long as the child has legitimate earned income.

Starting a Roth IRA at 16 with even small contributions gives decades of tax-free compound growth — potentially one of the greatest financial advantages a parent can give a teenager.

What to Invest In

For a child's account with a 10-60 year time horizon, a 100% stock allocation in a broad market index fund is appropriate:

• FZROX (Fidelity Total Market, 0.00%) — at Fidelity
• VTI (Vanguard Total Market ETF, 0.03%) — at most brokerages
• SCHB (Schwab Total Market ETF, 0.03%) — at Schwab