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Being a parent offers you endless opportunities to teach your children valuable life lessons, even if they don’t always seem to be listening. I might be biased, but one area that can give your kids a head start is to teach them about investing. Learn more about the types of investment accounts for kids that you can open their behalf that will not only help them fund their education but can provide a solid foundation for their future—all while improving their financial literacy.
It’s good to invest money for your kids as early as possible due to the power of compound interest. It allows their investments to grow exponentially over time because it’s earning interest on the interest.
There’s no magic number other than to start with whatever you can to give that money a chance to grow over time.
Types of Investment Accounts for Kids
529s and Using Investment Accounts as an Educational Opportunity
If you are looking for a tool to invest for your child’s future college expenses, a 529 plan may be a good choice. There are high contribution limits, anyone is eligible to contribute to a child’s 529, and there are tax advantages.
Benefits of a 529 Plan
High contribution limits: Each state's plan may have its own specific contribution limits, but most allow you and anyone else who wants to save a substantial amount of money for your child’s education. CollegeInvest has comprehensive information about 529 plans in Colorado.
Tax advantages: While contributions to a 529 plan are not deductible on your federal income tax return, the earnings in the plan grow tax-free. Additionally, withdrawals from the plan are also tax-free when used for qualified education expenses. Finally, contributions made as a gift to a 529 are removed from the contributor’s estate for tax purposes.
Flexibility: If you have more than one child and they don’t need all the money saved for them in a 529, the balance can be used for a sibling’s (or even another relative’s or yourself!) education expenses. And there is a new tax law passed that allows leftover funds in a 529 to be switched to a Roth IRA designation for the child after 15 years.
Custodial Roth IRA
If your child has earned income from a part-time job, they may qualify for a custodial Roth IRA. If you’re a business owner, have your kids help you out with your administrative tasks and put them on your payroll. And babysitting and dog-walking count.
The account needs to be opened as a custodial account, which means you the parent must open and manage the account assets until your child reaches 18 (or 21 in some states). You need to pay attention to contribution limits on the account, which for 2023 is the lesser of $6,500 a year OR an amount equal to what they earned.
Benefits of a Custodial Roth IRA
The earnings from your or your child’s contributions grow tax-free.
Your child can use the money that was put into the account (though not the earnings) tax-free for big expenses like a car or house down payment at any time.
Your child can withdraw money, including earnings, tax-free from the account without early withdrawal penalties if it’s used to pay for qualified education expenses.
After five years, your child can take out up to $10,000 in earnings to buy a first home, tax-free and without penalty.
And just think about this. if your kid can leave the money alone all their childhood and work years, they could end up with quite a nice nest egg over a period of 50-some years with compounding.
Coverdell Education Savings Accounts
Similar to 529 plans, Coverdell Education Savings Accounts are investment accounts for your child’s education. Contributions grow tax-free, and withdrawals are tax-free when they’re used for qualifying education expenses, such as tuition or books.
Unlike 529 plans, Coverdell accounts have strict contribution limits. The maximum you can contribute is $2,000 per year per beneficiary. Higher-income households—those with a modified adjusted gross income (MAGI) between $95,000 and $110,000 per year, or $190,000 to $220,0000 if you are married and file a joint return—have a reduced contribution limit. Those with incomes over those thresholds are ineligible for a Coverdell.
UGMA/UTMA Custodial Accounts
The Uniform Gift to Minors Act and Uniform Transfer to Minors Act (UGMA/UTMA) accounts are types of custodial trust accounts. A parent or relative can open an account on behalf of a child, and they act as the account custodian until the child comes of age. Depending on your state, the age the child takes over the account ranges from 18 to 25.
The custodian can make contributions and invest that money into stocks, bonds or mutual funds to grow the account balance. Other family members can also make contributions to the account.
According to Courtney Hale, a financial analyst and founder of Super Money Kids, UGMA/UTMA accounts have some benefits over a 529 plan. “These custodial accounts have more flexibility in that the funds can be used for things beyond education, but they do not have as many tax advantages,” says Hale.
Withdrawals from the account can be used to pay for a child’s education or anything else that benefits them. Once the child reaches the age of majority in their state, the account is under their control to use as they wish. The child can use the money to pay for college or toward a down payment on a home.
Brokerage Account
Some brokers have accounts specifically designed for teens. Stocks, bonds, mutual funds and ETFs can be purchased for a variety of investment options. Involving children in a few select stock picks is also a great way to get them interested in investing at an early age. Unlike other options that require a parent or relative to act as the custodian, these accounts give ownership to the child. However, parents or relatives should always monitor a child’s account activity.
Exposing My Kids to Investing – At What Age Should I Start?
Exposing kids to investing in the market at an early age might also encourage them to focus on building wealth through investments as adults. It might seem hard to get your kids interested in stocks when it competes with Roblox or sports but here are a few ways to get your kids started with investing. While Investor Junkie recommends starting at age eight, you will need to know your child and gauge their attention span. Making it fun and watching the investment grow together can spark interest and build engagement.
The book "Make Your Kids a Money Genius" is an indispensable guide to raising financially literate children. By implementing the practical advice and age-appropriate financial lessons presented in this book, parents can lay a solid foundation for their children's financial future.
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References
Disclosures
No investment strategy assures success or protects against loss. Investing involves risk, including the loss of principal. The information in this post is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This information should not be relied upon as the sole factor in an investment making decision.
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