Index Funds for Kids: Starting Early
A broad index fund bought when a child is young has 50+ years to compound. The hard part isn't the fund choice — it's picking the right account wrapper and understanding who owns the money.
Don't have time? Here's what you need to know:
- 1Money invested for a young child has 50+ years to compound at the market's ~10% long-run nominal average — time does the heavy work.
- 2A custodial Roth IRA is the most tax-efficient option, but it requires the child to have earned income.
- 3Custodial UGMA/UTMA accounts trigger the "kiddie tax" above modest income thresholds and become the child's property at the age of majority.
- 4The fund itself is simple — a 0.03% broad-market ETF like VTI or VOO; the real decision is which account wrapper fits your goal.
Why a Decades-Long Runway Changes Everything
The single biggest advantage a child has as an investor is time. Money invested at age five has six decades to compound before traditional retirement, and at the S&P 500's long-run average of roughly 10% nominal per year, that runway does almost all the work. A modest sum left alone can multiply many times over without another dollar added.
That is why a low-cost, broad index fund is such a natural fit for a kid's account. You are not trying to be clever or time anything — you are simply buying the whole market and handing the position the one thing children have in abundance and adults do not: an extremely long holding period. A single fund like VTI or VOO gives thousands of companies' worth of diversification at an expense ratio around 0.03%.
Tip: The fund choice is the easy part. Spend your energy on the account type and the tax rules below — that's where the real decisions live.
The Three Ways to Hold It: UGMA/UTMA, 529, and Custodial Roth
You cannot open a regular brokerage account in a minor's name, so the money has to sit in a special wrapper. There are three common choices, and they are not interchangeable — each has different rules about ownership, taxes, and what the money can be used for.
A custodial account (UGMA or UTMA, depending on your state) is the most flexible: you, the custodian, manage it until the child reaches the age of majority, at which point it becomes legally theirs to spend on anything. A 529 plan is purpose-built for education and grows tax-free for that use. A custodial Roth IRA is the most powerful of all, but it requires the child to have earned income.
| UGMA/UTMA | 529 Plan | Custodial Roth IRA | |
|---|---|---|---|
| Use of funds | Anything (once adult) | Education | Retirement (flexible withdrawals of contributions) |
| Tax treatment | Taxable; kiddie tax applies | Tax-free for education | Tax-free growth |
| Contribution limit | None (gift-tax rules) | High (per-state caps) | Up to the child's earned income |
| Who controls it later | Child, at majority | Account owner (you) | Child, at majority |
| Requires earned income? | No | No | Yes |
The Kiddie Tax: The Catch With Custodial Accounts
Investment income in a UGMA/UTMA account belongs to the child, and a portion of it each year is tax-advantaged — a first slice is effectively tax-free and a second slice is taxed at the child's low rate. Above those thresholds, however, the "kiddie tax" kicks in and the excess is taxed at the parents' marginal rate, which removes much of the tax benefit people assume a kid's account provides.
For a buy-and-hold index fund this is usually manageable, because a broad-market ETF throws off relatively little taxable income year to year and you control when gains are realized. But it is a reason not to assume a custodial account is automatically tax-friendly. If the account grows large, the dividends and any sold positions can generate a real bill.
Important: Custodial money legally becomes the child's at the age of majority. They can spend it on anything — not necessarily what you intended. If that worries you, a 529 (which you keep controlling) may suit you better.
Want the full framework? This 2-hour ETF course teaches you exactly how to pick, buy, and hold profitable ETFs — from zero to confident investor. Under $15.
The Quiet Winner: A Custodial Roth IRA
If your child has any earned income — a summer job, babysitting, tutoring, modeling, helping in a family business — you can open a custodial Roth IRA and contribute up to the amount they earned, capped at the annual IRA limit. Money goes in after tax, then grows and comes out completely tax-free in retirement. For someone with a 50-year horizon, tax-free compounding is extraordinarily valuable.
Fill it with the same simple index fund you would use anywhere else. A teenager who contributes a few thousand dollars from part-time work across several years can end up with a Roth balance that, left untouched, dwarfs the original contributions by retirement. The earned-income requirement is the only real gate — clear it, and this is the most tax-efficient way to invest for a child.
Frequently Asked Questions
What's the best account for investing for my child?
It depends on the goal. For education, a 529 plan grows tax-free for qualified school costs. For maximum long-term growth and tax efficiency, a custodial Roth IRA wins — but only if the child has earned income. A UGMA/UTMA custodial account is the most flexible for general saving, with the trade-off that the money becomes the child's outright at the age of majority.
Do I pay taxes on a custodial account for my kid?
Yes, in part. The income belongs to the child, and a first portion each year is tax-free or taxed at the child's low rate. Above those thresholds, the "kiddie tax" applies and the excess is taxed at the parents' marginal rate. A broad index fund generates relatively little taxable income, which helps keep the bill small.
Can a child have a Roth IRA?
Yes, through a custodial Roth IRA, as long as the child has earned income from a job or self-employment. You can contribute up to the amount they earned, up to the annual IRA limit. The account grows tax-free and gives a child the longest possible compounding runway.
How much do I need to start investing for a kid?
Very little. Many brokers have no account minimum and offer fractional shares, so you can buy a piece of a broad index fund for a few dollars. What matters more than the starting amount is the decades of compounding time a young child has ahead of them.
Further Reading
Free Tools
Alex Harrington
CFA Level II Candidate, Finance & Economics
Alex Harrington is an independent ETF researcher and personal finance writer with over 8 years of experience analyzing exchange-traded funds. A CFA Level II candidate with a background in economics, Alex has reviewed 800+ ETFs and helped thousands of beginners build their first investment portfolios through clear, jargon-free education.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results. Consult a licensed financial advisor before making investment decisions.