Investing for Kids: Creating A Bright Financial Future

The easiest way to create a millionaire isn’t to become one yourself – it’s to invest for your kids and make them one.

Why? Compound interest + TIME is the magic formula. Kids have more time than you, meaning their ability to accrue wealth is significantly higher.  Here's some sample numbers to give you an idea:

One way to do this is by utilizing various investment vehicles, such as UTMA accounts, 529 plans, Custodial Roth IRAs, and taxable brokerage accounts. These options provide unique advantages and opportunities for children to grow their wealth, learn valuable financial skills, and achieve long-term financial goals. Let’s break down account types and how you can use them.

UTMA Accounts

UTMA (Uniform Transfers to Minors Act) accounts are a popular choice for parents and guardians who want to invest on behalf of their children. These accounts allow for the transfer of assets, such as stocks, bonds, and cash, to a minor, with an appointed custodian overseeing the account until the child reaches the age of majority (usually 18 or 21, which is determined by each individual state). UTMA accounts offer tax advantages, as the first $1,100 of investment income is tax-free, and the next $1,100 is subject to the child's lower tax rate. They do effect future FASFA applications, which is a very important factor to consider when using these accounts. 

529 Plans

For parents looking to save for their child's higher education expenses, 529 plans are a fantastic option. These tax-advantaged investment accounts allow for contributions to grow and be withdrawn tax-free when used for qualified educational expenses, such as tuition, books, and room and board. Additionally, some states offer tax incentives for contributing to a 529 plan – many of which can be really powerful. Indiana offers a maximum of a $1,000 tax credit for contributing $5,000 to a 529 account. 

Determining future costs of college is an important aspect of planning here. Tuition costs increased 180% from 1980 to 2020, while median wages have only increased by 50.4% over the same time frame (Data from Forbes). This is a visual of anticipated future college costs for in-state vs out-of-state vs private tuition in 18 years, assuming a 5% college tuition annual increase.

Decide early what portion of education costs you plan to cover, and discuss this with your child as soon as you deem it age appropriate. Setting expectations of need for scholarship applications, grants, loans, etc can help you child plan for their goal's appropriately.

Remember, 529 plans have several unique aspects that allow them to be useful for more families.

-        You can transfer the beneficiary at any time without penalty

-        Funds can be used for K-12 education expenses, trade school, etc

-        As of 2024, you can roll over a lifetime maximum of $35,000 from a 529 into the same beneficiary's Roth IRA. Rolling over funds from a 529 plan to a Roth IRA are subject to the earned income requirements, annual contribution limits and income limits. Thus, it would take ~5 years to roll over the lifetime maximum of $35,000. Both accounts need to be open for 15 years before a Roth IRA conversion can happen, so start early.

Custodial Roth IRAs

A Custodial Roth IRA is another valuable investment tool for kids. It offers a unique advantage of tax-free growth and tax-free withdrawals in retirement. Parents or guardians can open a Custodial Roth IRA on behalf of their child, with the child assuming control of the account once they reach the age of majority. By contributing to a Roth IRA early in life, children can benefit from the power of compounding and potentially build a substantial retirement nest egg. Additionally, contributions made to a Roth IRA can be withdrawn penalty-free for certain qualified expenses, including education costs or a first-time home purchase. Your child has to report an EARNED INCOME to the IRS to utilize this account, and can’t contribute more to this account than they report as earnings in any given year. If you meet the requirements, I think this is the most powerful account for building wealth for kids. 

Taxable Brokerage Accounts

Taxable brokerage accounts provide flexibility and a broader range of investment options. Unlike tax-advantaged accounts, these accounts don't offer specific tax benefits but allow for greater control and accessibility (and still favorable capital gains tax rates). Parents or guardians can create their own separate taxable brokerage account, and simply earmark it for their child in the future. This gives maximal flexibility. 

Investment Real Estate

Investment real estate can be a unique and exciting opportunity for kids to learn about property ownership, passive income, and long-term wealth building. While it may not be feasible for every family, investing in real estate for kids can provide valuable lessons in financial responsibility and asset management. Parents or guardians can consider purchasing rental properties with the intention of transitioning ownership to the child in the future (bearing in mind tax implications of this). This hands-on approach can teach children about property maintenance, tenant relationships, and the potential for rental income. Additionally, real estate has the potential for appreciation over time, making it a long-term investment strategy that can help children accumulate wealth and secure their financial future.

Remember, investing in real estate involves risks, such as property market fluctuations and unexpected expenses. It's essential to take a long-term perspective, have a solid financial plan, and be prepared for the responsibilities that come with property ownership. By combining real estate investing with other investment vehicles like UTMA accounts, 529 plans, Custodial Roth IRAs, and taxable brokerage accounts, parents can create a comprehensive and diversified investment strategy for their children, setting them on a path towards financial independence and success. 

Investing for kids through UTMA accounts, 529 plans, Custodial Roth IRAs, and taxable brokerage accounts can have a profound impact on their financial future. By starting early and taking advantage of tax benefits and compounding, children can grow their wealth, learn valuable financial skills, and achieve long-term goals. It is crucial for parents and guardians to actively involve children in the investment process, educating them about money management, risk, and the power of long-term investing. By nurturing their financial literacy and providing them with the tools to succeed, we can empower the next generation to make smart financial decisions and secure a prosperous future.

I haven't mentioned the most important part yet...

Do not invest for kids if your own financial independence isn't secure!

You need to apply your own oxygen mask before helping others. If you are going to be a future burden to your children because you aren't able to support your basic needs in retirement, investing for your kids had the opposite effect you intended.

If you're not on track for your own financial independence, use the links below to get help.