What's the Best Investment Plan For a Child's Future?

Mar 01, 2022

What’s the Best Investment Plan For a Child’s Future?

Parents sacrifice a lot for their kids, always wanting them to be set-up for success in life. Many are stuck in the day-to-day events, wanting to invest in their child’s future but unsure about how to start.
Is it better to put money aside for a college fund so that your child doesn’t have debt after school? Or is it more important to invest towards their retirement?
It doesn’t matter if your child is a newborn or graduating high school. There are various options to choose from to begin investing, setting your child on a positive financial path into the future.

What Does Your Financial Health Look Like?

Stop and ask yourself if you can begin investing for your kid financially. This is a huge step in order to succeed with investments.
Why? Because you need to take care of your personal finances first before you can build someone else’s. If you don’t, the table may turn over the years and you may become dependent on your own child.
If you are debt-free, have a fully funded emergency fund, and are already investing 15% of your income towards your own retirement, you are in a solid place to put money aside towards your child’s financial gain.

How To Invest In Your Child’s Future?

Wouldn’t it be nice to live in a world where money didn’t matter? Unfortunately, it is a foundation for us and the world revolves around it. The good news is that there are a variety of options parents can choose from to begin investing in their child’s future, whether it is to buy a car, living expenses, or tailored specifically to a higher education.

Types College Investment Funds

Student loan debt is one of the largest regrets Millennials are facing today. Over 84% wish that they could go back in time to change the decisions they are now responsible for.
As a parent, there are savings options available that you can invest in now to prevent your child from feeling the same frustration Millennials do. Let’s cover the various options next.
529 College Savings Plan
A 529 plan is a tax-advantaged savings plan. Money invested in the account is deposited using after-tax monies. Additionally, any growth earned in this plan remains tax-free as long as the funds are used for qualified educational expenses such as tuition, room and board, textbooks, and more. Using this plan for nonqualified expenses subjects you to a 10% penalty on earnings and income tax.
The 529 college savings plan may include the word “college,” but it also has a secondary use. Before stepping foot into college, children who attend private schools are eligible for disbursements of $10,000 per year from the plan to pay towards their tuition. The max balance for this account ranges between $300,000 and $500,000.
Friends and family members can contribute to a 529 college savings plan, bringing the costs of your child’s future education down significantly. Up to $15,000 per child is giftable to this account without having any tax implications. Only cash contributions are accepted in this account. It cannot be funded through other investments.
When opening a 529 college savings plan, the parent is deemed the owner having the ability to name the beneficiary (the child) of the account. This gives you flexibility in the event you need to make a change to whom benefits from the fund. Plans vary in investment options from the inclusion of index funds, mutual funds, ETFs, etc.
Prepaid Tuition
If you are certain that your child plans to attend college, look into prepaid tuition options. By prepaying, you are locking in today’s tuition rates, not the inflating rates of tomorrow. Although you can, prepaying doesn’t mean you need to pay the tuition in full. Installment payments are optional and may even extend to cover graduate school too.
How does it work? A formal contract drawn up including the projected cost of tuition and rate of return. The funds then pool into long-range investments with the expectation that the growth of the accounts will meet or exceed the projected costs of your child’s tuition. You never handle the funds either. When it’s time to execute the agreement, the funds are transferred directly to the college.
There are a few restrictions to prepaying tuition. For example, most states require that you or the future student resident within the state the prepaid tuition plan is being offered at the time the application is submitted. They may even have age limits or grade requirements.
Check with your state before entering into a contract for prepaid tuition. Most states guarantee the funds; however, there are some that do not, resulting in a future obligation for your child to cover the difference in cost.
Education Savings Account
Also referred to as an ESA or Coverdell Savings Account, an education savings account is a great place for families to start when it comes to your child’s future tuition expenses.
An ESA account works similar to that of a Roth IRA with a focus on education expenses. It limits contributions to $2,000 post-tax annually per child and grows tax-free. Don’t get hooked on the fact that this is a savings account. It operates at a higher rate of return than an average savings account with the added bonus of not having to pay taxes until it’s time to withdraw the funds to pay the tuition bill.
Just like the other types of education savings plans, the ESA can be used to pay for private tuition, vocational school, school supplies, textbook, tutoring, and more. The only caveat is that the funds must be used before the age of 30.

Other Types of Kid-Friendly Investment Accounts

If you want to save money for your child, and want it to be accessible to them for expenses outside of education, here are a few options you can consider.
UGMA and UTMA Accounts
Let’s get definitions out of the way. UGMA stands for Uniform Gifts to Minors Act. UTMA stands for Uniform Transfer to Minors Act.
Now that the formalities are complete, what are UGMA and UTMA accounts? These are a fancy way of saying custodial brokerage accounts. Parents can open an UGMA/UTMA account for their child’s future expenses. This type of account is not limited to school tuition and higher education costs. It is also used to purchase just about anything, even clothing.
A custodial account is a good choice for families that are not focused specifically on education when investing for their child. There are not as strong tax advantages to UGMA/UTMA accounts as they are for college education plans, such as the 529 college plan. The general tax rule is this:
  • The first $1,100 of annual unearned income is tax-free
  • The second $1,100 of annual unearned income is taxed at the child’s tax rate
  • Annual unearned income exceeding $2,200 is taxed at the parent’s tax rate, which is typically larger than that of the child.
Both cash and investment contributions are welcome with the UGMA/UTMA accounts. Stocks, bonds, and mutual funds are welcome. With UTMA accounts, you can also include real estate and patents.
If you set-up a custodial account, be prepared to have conversations with your child as they grow into adulthood. Explain to them why this fund was set-up and encourage them to save it or spend it for necessities.
Why is this important? The parent is in charge of the account up until the child turns 18 or 21 years old (depending on the state you reside in).
Custodial IRA
IRAs (Individual Retirement Account) are usually not thought about at an early age but they are a powerful tool in the investment world. Why not consider setting one up for your child? As long as your child has a source of income, an IRA can be opened in their name with you, as the account owner, building up the fund.
Both Traditional and Roth IRAs are available to children, with the highest recommendation awarded to Roth IRAs. Why? Roth IRAs are famous for growing tax-free, but remember - when it’s time to withdraw money the tax implications begin.
How much can you contribute to your child’s IRA? Parents can give the lessor of $6,000 per child or the total annual income earned.
For example, if your child has a summer job and only brought in $2,500 for the year, then contributions are capped at $2,500. This is still a great deal of money in the investing universe though, don’t underestimate its power to grow through the use of compound interest.
Brokerage Account
Not interested in a Traditional IRA or a Roth IRA? No problem. There are alternatives, such as brokerage accounts, that allow you to invest your money into various securities, including stocks, bonds, mutual funds, ETFs, and more.
Brokerage accounts are a fan favorite for all ages, including young investors. Teaching your child now about stock trading practices is both fun and educational.
Involve your child in the selection process if they are old enough. For example, pick out company stocks to add to their portfolio that they are familiar with or have interest in.
Ready to select a broker? Pause and do your homework first. Compare broker fees, searching for those that preferably do not charge fees on trades and that don’t require a minimum account balance.

Can You Begin Building Your Child’s Credit Now?

You can give your child’s credit a boost at an early age so they don’t need to worry about their credit score initially. Here are a couple of tips as to how you can help
  • Add your child as an authorized user on your credit card, but make sure you keep up the positive payment history and keep utilization low!
  • Apply for a secured card for your child

The Bottom Line

Take advantage of the investment options available to you and your child today while they are young. Best practices include investing early, utilizing methods like compound interest, tax advantages and the ability to transfer between beneficiaries. Don’t hesitate if you are unsure of which plan best suits your family's needs. Consult with a financial professional to begin building your child’s future wealth.
Building an investment portfolio protects you in the future, whether it is there for your plans of retirement, future child care expenses, buying a home, and more. ETFs are a strong option to add to your investment strategy.
Visit LifeGoal Investments to learn more about ETFs available to you and how they can quickly get you the results you are looking for.
Investing for Your Kid's Future | RamseySolutions.com
Investing For Kids: Give The Gift Of Stock This Christmas | Forbes
Investing For Kids - How To invest For Your Kid's Future | Money Under 30
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