Investing For Your Child’s Future
03/20/24
If you’ve made the decision to invest for your child’s future, you have a few options. Here are a list of the most common three accounts I see used. After I lay these out, I will share with you my favorite option along with a brief explanation!
1. Start a 529 Plan
Benefits:
- State tax is deductible on contributions if using your own state’s plan
- Tax-free withdrawals if money is being used for education
- Can roll funds into a Roth IRA for the child after 15 years if money is not used
- Very high maximum contribution limits
Downsides:
- There is a 10% penalty on gains if funds are used for non-education expenses
- Funds that are rolled into a Roth IRA after 15 years are done each year up to the maximum. For example, the 2024 maximum is $7k. If you were 25 years old and rolling $7k over from your 529 Plan to your Roth IRA, this counts as a contribution, meaning you could no longer contribute new money into your Roth IRA this year.
Some states offer plans that lack great investment options.
2. Start an UGMA Account (Uniform Gifts to Minors Act)
Benefits:
- Funds can be used for any purpose
- The first $1,300 of unearned income is not taxed. The next $1,300 is taxed at the child’s lower tax rate (kiddie tax). Any amount over that is taxed at the parent’s marginal income tax rate.
- Easy way to legally transfer money to your child without creating a trust
- No contribution limits
- Thousands of investment options
Downsides:
- Contributions are irrevocable
- Money is in the child’s name, so these count as assets if the child applies for federal financial aid while applying for college, possibly decreasing the aid received
- Money legally becomes sole property of child when they reach age of majority (varies by state), meaning it is theirs to do what they would like with no matter your intentions.
- No tax benefits
3. Start an Individual Account in your name:
Benefits:
- Funds can be used for any purpose
- You have full control over the funds and can pass along the funds to your child as needed at any point
- You can gift the funds in pieces if desired rather than all at once
- No limit on investment options
- If your situation changes, the funds are still in your hands.
Downsides:
- No tax advantages
My preferred option is number 3, starting an Individual Account in your name and passing it along to your child(ren) when ready. While it is not the most tax efficient, it is outweighed by the flexibility and control it gives parents to help their children move financially forward at their own pace.
*This is not meant to be an exhaustive list. This is simply a baseline to follow. Please talk with me about your specific situation. I never charge for meetings or advice; I only get paid directly from accounts that I manage.