One of the most important aspects of parenting that most people tend to forget about is teaching your children to be financially responsible. Lessons on money management, saving, and investment should be taught throughout their lives so that they leave your house armed with as much knowledge as you can give them – this way, they’ll be better equipped to face the “real world”.
Minor children aren’t able to open up anything beyond a savings account for kids, but as parents, there’s so much you can do to help them get started on their investment journey. This will help them learn important money lessons such as compound interest, passive income, and more which will help them out later in life.
Here are 5 of the best investment accounts that are ideal for children:
Custodial Roth IRA
If you have an older child who has his/her own income, even if it is from a part-time job, they may qualify for a custodial Roth IRA. These contributions, like any other Roth individual retirement account, grow tax-free.
While the assets in a custodial IRA are controlled by the parent who opens the account until the child turns 18 (or 21, in some cases), they are allowed to withdraw contributions (but not the earnings) for major expenses like a down payment for a car or house, given that the account has been funded for a minimum of five years prior.
The child may even withdraw money from the account, including earnings, without being charged any early withdrawal penalties for proven qualified education expenses such as college tuition.
While an individual has to be at least 18 years of age to open a brokerage account, minors can still partake in this form of investment through a custodial brokerage account. Here, a parent or guardian opens a brokerage account on behalf of the minor and maintains it until they turn 18.
Although custodial brokerage accounts are not tax-deferred, they are a fantastic way to help teens learn important investment concepts and build life-long investing habits. Although the parent holds control of the account, the child is allowed to make decisions such as where and what to invest. They can pick from a range of stocks, bonds, mutual funds, and ETFs.
A number of traditional brokerage companies such as Fidelity, E-Trade, and Charles Schwab now offer youth accounts, but there are also newer companies like Stockpile, Acorn, and Greenlightcard which make it so much easier for young children to get started on their investment journey. Since everything can be done online nowadays, it is a lot easier for teens to start and maintain their investments. These brokerage accounts do charge a nominal monthly fee, but teens can start investing with a small minimum balance.
529 Education Fund
A 529 fund, legally known as a “qualified tuition plan” is a tax-advantaged savings account that can help you build up an investment specifically for the purpose of your child’s future education. There are no limits for contributing to a 529 savings plan, although there is a maximum amount that can be claimed as gift tax, and anyone can open/contribute to the account. Withdrawals made to be used for qualified education expenses, whether they be college tuition costs, or even elementary or secondary school tuition fees, are tax-free.
There are two types of 529 plans:
- Prepaid tuition plans, where the charges are based on current rates for application and enrollment fees as well as ongoing administrative costs.
- Education savings plans, where you select an investment option from a range of mutual funds and exchange-traded fins (ETFs) to help pay for college enrollment charges, annual account maintenance fees, ongoing program management fees, and ongoing asset management fees.
Generally speaking, an education savings plan would be the better choice as it allows for a number of fee waivers based on certain criteria, but it is better to go through them both thoroughly to make an informed choice. There are also certain limitations, such as not being able to easily move across the pre-set investment options, and restrictions on withdrawals if the child chooses not to go to college or go to a non-participating college – in which case, a 10% tax will be levied.
Coverdell Education Savings Accounts
A Coverdell education savings account is very similar to a 529 education fund, with a few modifications here and there. Like the 529 funds, contributions to Coverdell accounts are tax-deferred and grow tax-free. Withdrawals are also tax-free, given that they’re used for qualified education expenses.
Some of the major differences between a Coverdell account and a 529 fund is that the former comes with an age cutoff of 18 years old and maximum contribution amount of $2000 per year, per beneficiary (higher-income households have an even lower contribution limit!). Plus, the beneficiary must also use the money in the fund by the age of 30.
However, the main advantage a Coverdell account has over 529 funds is that the withdrawals can be used in a wider application, as long as it pertains to education costs – whether it be tuition fees, book expenses, accommodation, or anything similar. At the same time, Coverdell accounts also have more flexibility when it comes to investment plans and options.
UGMA/UTMA Trust Accounts
One of the most common custodial trust accounts that can be opened for minors is the Uniform Gift to Minors Act or s (UGMA/UTMA). The parent/guardian of the child opens a UGMA on their behalf and maintains control of it until the child reaches the age of 18 (or up to 25, depending on your state).
The account opener can make a contribution to the account and invest the money in a wide range of options from stocks and bonds to mutual funds which will help grow the balance. Other family members are also allowed to make contributions to the account.
The main advantage of a UGMA/UTMA trust account is that the funds can be used for things beyond just education and the account switches over to the complete control of the beneficiary once they reach the stipulated age limit. They can use the money for whatever they want, be it to pay for their college tuition or make a down payment on a house or car. However, it should be noted that custodial accounts like these do not have as many tax advantages as a 529 fund or Coverdell account.