It’s natural to wonder what the “best” investment plan for your child’s future is. The reality is that there is no one right answer to provide a solid start for your kids. However, there are a few things you can do to start saving on behalf of your child — no matter their age.
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Custodial Investment Accounts
First, you can open custodial accounts for your kids. I have a custodial account at Stockpile for my son. It’s a great tool for him to learn about investing and how it can help him grow his wealth over time.
You can start a custodial account on behalf of your children no matter their ages. However, be aware that when your child turns 18 or 21 (depending on your state), they have full access to the account.
Don’t forget, though, that there might be situations in which your child is subject to the “kiddie tax.” Of course, this depends on the investments you choose and whether they’ve earned enough dividends and interest to trigger the tax. Consult a tax professional if you’re not sure about your situation.
What About Custodial IRAs?
While you’re considering custodial accounts, don’t forget about IRAs. As long as your child is earning income, they can have an IRA — and you can make contributions to it.
Many parents with businesses hire their children to work for them. My son occasionally does some social media scheduling for me and handles other administrative tasks for my business. When you pay your child, though, it’s important to make sure you’re following proper laws and procedures and creating a paper trail.
If you can establish that your child works, you can pay them and they’re eligible for an IRA. You can choose a Roth IRA or a Traditional IRA, based on the tax situation you think they will most benefit from.
Plus, money from a custodial IRA can be used later for non-retirement expenses like a down payment on a house or education without penalty. Double-check the rules to make sure you’re handling it correctly so your child gets access to the best start.
529 Savings Plans
The cost of college keeps rising, so it can make sense to help prepare your child for those costs–and potentially reduce their need for student loans.
All 50 states offer 529 plans with different benefits. While you won’t receive a federal tax deduction for contributing to a 529, some states offer their own tax breaks that can give you an extra advantage. Additionally, money in a 529 grows tax-free as long as it’s used for qualified educational expenses, so your child won’t have to pay taxes when they withdraw the money for college.
Carefully consider the pros and cons of a 529 plan before you invest, and make a choice that works best for you and your family.
Another option is to keep savings for your child in cash. However, while the principal will be safe and protected from the ups and downs of the stock market, you won’t see very big returns in the form of interest. You can set up a joint account or a custodial account.
You can also use a CD ladder strategy, saving on behalf of your child for years into the future. This can be one way to safely save, and then turn the money over to your child (or use Uniform Gift to Minors Act– UTMA/ Uniform Transfer to Minors Act – UGMA accounts) later. The returns on these accounts aren’t going to have the same potential as investment accounts.
With these criteria in mind, here are our top choices for the best child savings accounts:
Potential for Loss
While investing on behalf of your children can be a smart move, it’s important to understand the potential risks. When you use an investment plan, you could lose money. If the stock market crashes right when you need to sell stocks to pay for college, you could end up losing out.
You’re less likely to have devastating losses when you start early and invest consistently, but it’s still possible. And, even if the money is there and accomplishes its purpose, it can be a difficult pill to swallow when you have to sell low.
As you invest, make sure you take into account time horizons and asset allocation when deciding how to manage your child’s investments.
Financial Aid Implications for Some Accounts
It’s also important to understand that some accounts will impact your child’s financial aid. Assets in an account managed on behalf of a minor are still considered theirs, so there may be a possibility that they will be included in calculations for financial aid. Depending on the situation, it can reduce your child’s eligibility for need-based aid, including some scholarships.
Before you decide on an investment plan, speak with a knowledgeable financial professional about the potential ramifications. You might discover that some plans are better than others in ensuring that your child gets the maximum help from you.
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Teach Your Child Good Money Management Lessons
Don’t forget to teach your child good money management habits while you’re saving for their future. It’s not enough to set money aside for them and then just present it to them later. Your children should know how to manage their own money and understand the value.
If you’re making contributions to an account, encourage them to contribute as well. My son makes contributions from his earnings to the accounts that are for his future. He knows that putting aside some of the money he earns is important–and it should be a priority. Plus, encouraging your children to put some of their own money in promotes the idea that they have skin in the game.
Getting your children involved in money management principles from the get-go gives them good practice for the future, and it will (hopefully) help them avoid making huge financial mistakes later. One of the best investment moves for your children is to teach them about investing and get them involved at some level.
Don’t Put Your Retirement at Risk
The good news is that you can work on multiple goals at once. You can set money aside for retirement while investing on behalf of your child. Just don’t put your retirement on the line for your child’s future. Carefully prioritize your goals so that you’re taken care of, as well as providing a good start for your children.
As your retirement portfolio grows, and as you get a handle on the situation, you can increase how much you put into an investment plan for your child’s future.
You don’t have to ensure that your child is set for life or that they don’t have to get student loans at all to provide them with a solid foundation for their financial future. Even just starting small with an investment account like a custodial IRA or a 529 can go a long way toward helping them start on the right financial foot.
Create a plan and stick to it, and your child will thank you.