Investing in Your Child's Future
Parents can achieve incredible financial gains for their children by beginning the investment process now.
While understanding what the best investments for kids are, it’s a broader topic in the sense that there are many important facets to the discussion. Things like when you should begin investing for your kids, what types of accounts are appropriate for kids, and what are the tax ramifications of various investment strategies. When it comes to investing on behalf of your children and making strides towards their very bright financial future, all of these things can be important elements.
Investing for Your Child’s Experiences
If you want to save or invest money to help your child out with adult expenses or a down payment on their first house, you’ll want to put that money in an account that’s a little more liquid (or accessible) than a Roth IRA. While you won’t have the power of several decades of compound interest to follow your kids into their retirement years with these options, they will have access to the funds when they get to those major life events.
Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA)
If the account you want to open for your child is one you’re not planning to touch for five years or more, you can consider a Uniform Gifts to Minors Act (UGMA) or a Uniform Transfers to Minor Act (UTMA) account to invest in good growth stock mutual funds. You might think of these accounts as essentially custodial accounts that are non-retirement accounts.
What’s the difference between a UTMA account and a UGMA account? UGMA accounts are typically used for cash, stocks, mutual funds, bonds, and insurance policies where a UTMA account can also include any type of assets such as real estate and other items.
You can contribute to a minor’s UTMA or UGMA account based on federal gift tax exemption rules. It’s worth noting that these contributions are irrevocable meaning you can’t transfer them back.
Here are some of the key things you need to know about these accounts:
- Just like with a Custodial IRA, UGMA and UTMA accounts are opened in a child’s name and a custodian is named—usually a parent or grandparent. But you can choose anyone to manage the account.
- The custodian will have full control of the account until the child reaches a certain age.
- UGMA and UTMA accounts are often used to save for college—after ESAs and 529s—but the money can be used for anything.
- There are some tax advantages to using UGMA and UTMA accounts. Since they are in your child’s name, the accounts will be taxed according to their tax bracket. The lower tax rate for children means they’ll pay less in income taxes.
Discuss tax ramifications of a UTMA or UGMA account with your tax professional.
Your Own Savings Account
Some parents want to build the best investments for kids, but don’t necessarily want to fool with custodial accounts or open additional accounts in the children’s names. You can still set money aside “earmarked” for your kids in separate savings or brokerage accounts that remain in your name. Then, when you deem the time is right, you can give this money to your children. Make sure you’re examining all tax ramifications associated with gifting money to children.
Another possible route for investing for your kids is a certificate ladder. If you don’t want to mess with the market or IRS regulations, a simple CD ladder can be a great way to save money in your child’s name.
When implementing a CD ladder, you simply purchase multiple certificates of deposit with varying durations (and usually interest rates). This will result in having several CDs that mature at regular intervals. As long as you don’t need the money, you can continue to roll these CDs over into new terms. You can repeat this process as long as you wish to keep the money in savings and keep the money-generating interest.
Money Market Account
If the idea of basically handing your kids a blank check makes you nervous, you can open a money market account in your own name and save over time until you’re ready to gift the money in the account to your kids. Technically this isn’t investing, but money market accounts are really great for short-term savings goals (as in five years or less). They have low-interest rates, so your return won’t be much, but you will be in control of when and how your kids receive the money you plan to gift them.
Investing for Your Child’s Retirement
It’s never too early to begin saving for retirement. Setting just a few dollars aside each month can help your teen get a jump start on their retirement savings and experience the power of compound interest!
If your kid's college accounts are already funded, and the child is working a job, get that IRA going. IRAs, or Individual Retirement Accounts, are investment accounts geared towards saving for retirement. If your child has a part-time job, they don’t have to wait until they have a full-time job or are out of college to get started. There are no age restrictions on opening an IRA, so age will not prevent your child from opening an IRA.
They have various tax benefits depending on the type of IRA, and they have various restrictions around participation and how the money is withdrawn.
The primary participation restriction revolves around earned income. Your child must bring in some kind of earned income in order for you to be able to open an IRA in their name, and allowances don’t count. Plus, they can’t contribute more than what they make that year. Note that the IRS defines earned income as taxable income or wages. So, if your child has a W-2, he or she can contribute to an IRA.
IRA accounts can be opened as custodial accounts where the parent is often the custodian. The custodian manages the account until the minor reaches age 18 or 21 (depending on the state). The funds in the account belong to the child whether or not the child is still considered a minor.
Roth IRAs are more flexible than traditional IRAs. While typically withdrawing money from retirement accounts early comes with penalties, Roth IRAs let you withdraw the contributions early if you need the money (not the earnings/gains).
Why would a Roth IRA be so impactful for a child’s future?
The key to this is compounding. Starting in your teenage year's regular contributions can result in massive wealth being generated for later years. As long as your child is earning income, YOU as the parent can contribute to the Roth IRA in your child’s name. If you have the means, the long-term benefit here really can’t be overstated.
Investing for Your Child’s Education
529 College Savings Account
For parents or guardians looking to fund their children's education, a 529 tax-advantaged account is an optimal savings vehicle for K-12 tuition or college tuition.
A 529 plan, otherwise known as a qualified tuition plan, is a tax-advantaged savings account used for education expenses. Unlike other tax-advantaged savings accounts, a 529 has no income limits for plan contributions.
Anyone can contribute to a 529 plan, whether it be through monthly contributions or gifts from friends and family.
Education Savings Account
An Education Savings Account (ESA or Coverdell Savings Account) is another great college savings option. They’re simple and similar to an IRA, but there are a couple of limitations. First, the maximum you can invest in an ESA is $2,000 a year. And second, married couples making more than $190,000 a year and single parents bringing in more than $95,000 a year can’t make contributions to an ESA.
If you want to invest beyond the $2,000 limit or if your income exceeds the ESA income limits, you can put some extra dollars in a state-specific 529 plan.
Investing in your kids is not just about what you give them, but who they become.
No matter how you plan on investing in your child’s future, it’s important to sit down with your kids when they’re old enough and share your heart behind your gift. They should have the character, maturity, and wisdom to be a good steward of the financial gifts you are entrusting to them. In Dave Ramsey's book Retire Inspired, he explains that your greatest gift to your children and grandchildren will be what you leave in them, not what you leave to them. If you want your financial gift to be a blessing, make sure you’re teaching your kids the value of hard work and responsibility.
Ready to Start Investing for Your Kid’s Future?
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