Investing in your child's future is one of the greatest gifts you can give them. Starting early can set them on a path toward financial stability and independence. Thankfully, you don’t have to do it yourself, as grandparents and other family members can also contribute along the way.
At Vital Card, we take financial responsibility seriously and want to help educate our users as much as possible. Let’s discuss the various types of investment accounts available for kids, the benefits and considerations of each, and how to choose the one that best suits your child's needs and your financial goals.
Why should you consider an investment account for your child?
By opening an investment account for your child, you're not just contributing towards their future financial stability but also planting the seeds of financial literacy — a skill that will serve them well throughout their life.
Investment accounts provide a hands-on learning platform for teaching your child about money management. They can learn about the importance of saving, the concept of risk and reward, and the power of compound interest.
Compound interest, often referred to as “earning interest on interest,” is a powerful tool that can significantly increase the value of your investment over time. It's the interest you earn on your initial deposit (the principal) and the interest that money has already accrued.
Setting up an investment account for your child can also give them a financial head start. Whether the goal is to save for higher education or a down payment on a house, having an investment account starting from a young age can provide a substantial financial cushion. It's a way of securing their future and teaching them the importance of long-term financial planning.
What are the different types of investment accounts for kids?
Investing in your child's future is an important decision. Providers like Fidelity and Vanguard offer these types of accounts and can provide additional guidance based on your specific needs and circumstances. To help you sift through the options, we're going to break down the different types of investment accounts available for your child.
Each account type has its own unique features and advantages, so understanding them can help you make an informed decision that suits your family's needs and financial goals:
1. UGMA account/UTMA account
Custodial accounts are a popular choice for investing in a child's future. They’re established under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA), allowing you to open an account in your child's name and manage it until they reach the age of majority, which is typically 18 or 21, depending on your state.
The beauty of a custodial account is its flexibility. You can invest in a wide range of assets, including stocks, bonds, mutual funds, and even real estate. The account is irrevocable, meaning once money is put into the account, it cannot be taken back and it belongs to the child as they’re considered the account owner.
Remember, however, that the income generated by the account may be subject to the "kiddie tax," which taxes a portion of a child's unearned income at their parent's tax rate.
2. Custodial brokerage account
A custodial brokerage account is another option for investing on behalf of your child. This type of account allows you to buy and sell a variety of securities such as stocks, bonds, and mutual funds.
With a custodial brokerage account, you maintain control of the account and can make investment decisions based on what you believe is best for your child's financial future.
One thing to keep in mind with custodial brokerage accounts is that any money generated is viewed as taxable income. However, the tax rate will depend on the child's income, which is typically lower than an adult's, potentially resulting in lower tax liability.
3. Custodial Roth IRA
A Custodial Roth Individual Retirement Account (IRA) can be a fantastic option if your child has earned income from a job. This account offers tax-free growth and tax-free withdrawals for qualified expenses.
Contributions are made with after-tax dollars, meaning your child won't owe income tax on withdrawals in retirement. This can be a great way to kick-start their retirement savings and teach them from a young age about the importance of saving for their future.
4. 529 college savings plan
A 529 college savings plan is a tax-advantaged account designed specifically for saving for your child's qualified education expenses, including tuition, room and board, and books. The idea is to help your child avoid applying for much financial aid or taking out student loans that often come with sky-high interest rates.
Typically, these plans are sponsored by states, state agencies, or educational institutions. Earnings in a 529 plan grow federal tax-free and won't be taxed when the money is taken out to pay for furthering your child’s education.
5. Coverdell Education Savings Account
Coverdell ESAs are similar to 529 plans in that they’re designed for educational purposes. However, they’re more flexible in terms of what the funds can be used for.
In addition to college costs, Coverdell ESA funds can be used for elementary and high school expenses.
However, they come with lower contribution limits compared to 529 plans.
What investment options can you consider for your child's account?
The investment options available largely depend on the type of youth account you choose for your child.
However, most accounts offer a wide range of assets you can invest in:
Mutual funds, for instance, allow you to pool your money with other investors to invest in a diversified portfolio of stocks, bonds, or other securities.
Exchange-traded funds (ETFs) are similar to mutual funds but trade on an exchange like individual stocks.
Index funds are another type of mutual fund that aims to replicate the performance of a specific index, providing broad market exposure at a low cost.
On the other hand, fractional shares allow you to buy a portion of a stock, making investing in companies with high share prices easier.
Investing in individual stocks or real estate is another option. However, doing so comes with its own set of risks and rewards. It also requires a level of comfort and understanding of the stock market and housing market.
Remember, the goal is to choose an investment strategy that matches your financial goals, risk tolerance, and investment horizon.
How do you choose the best investment account for your child?
Investing on behalf of a child is a significant decision that should be made with careful consideration. It's not a one-size-fits-all situation. The best account for your child depends on various factors unique to your family's circumstances and financial goals.
Firstly, consider your child's age. If your child is young, you may have more time to invest and could potentially take on more risk for higher returns. On the other hand, if your child is older and closer to needing the funds, a more conservative approach might be more appropriate.
Your financial goals for your child are also important. A 529 plan or a Coverdell ESA might be the best fit if you're primarily saving for their education. However, a custodial Roth IRA could be a great choice if you want to give your child a head start on retirement savings.
The amount you're able to invest is another key factor. Some options have higher account minimum balance requirements or annual contribution limits than others. Be sure to choose an account that aligns with your financial capabilities.
Your child's potential eligibility for different types of accounts is also important. For instance, a custodial Roth IRA requires the child to have earned income, so this might not be an option for younger children.
Lastly, don't forget to consider the tax benefits and implications for each option. Some accounts offer tax-free growth, tax-free withdrawals for qualified expenses, or tax deductions. However, there may also be capital gains tax or gift taxes to consider depending on your investment and how you manage it.
Invest today for a brighter tomorrow
Investing in your child's future is a wise and thoughtful decision. It provides a financial cushion for the future and teaches valuable lessons about money and financial planning.
Whether you choose a high-yield savings account, a custodial account, or some other type of investment account, you're taking a significant step toward securing your child's financial future.
The team at Vital Card encourages you to share and spend responsibly, and we're here to support you on this financial journey. If you want to learn more about preparing your child to make wise financial decisions, then explore our blog for additional information.
Sources
Why Financial Literacy Is Important And How You Can Improve Yours | Forbes
What Is Compound Interest? | Experian
Topic No. 553, Tax on a Child's Investment and Other Unearned Income (Kiddie Tax) | IRS
What Are UGMA and UTMA Accounts? | Experian
Guide to Custodial Brokerage Accounts | Brokers and Advice | U.S. News
You're Never Too Young to Save for Retirement. Why a Custodial Roth IRA May Make Sense | USA Today
How 529 College Savings Plans Work and Why You Should Consider One Over a High-Yield Savings Account | CNBC
Topic No. 310, Coverdell Education Savings Accounts | IRS
What Is Capital Gains Tax? | Experian
Gift Tax | IRS
Vital Card blog posts are intended for informational purposes only and should not be considered financial or any other type of advice.