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How Should I Invest for My Kids?

My social media news feed has been filled with pregnancy announcements and newborn baby photos these days. I am of the age where many of my friends are settling down and starting families of their own, and naturally these parents are wondering what steps they can take today to set their kids up for future financial success.

Whenever this topic comes up, my first response is a return question. “How are your own financial goals progressing?” In my experience, many parents are willing to defer their own savings goals (including retirement) to fast track their children’s success. If you are not sure this sounds like you, here are some criteria to consider. Have you paid off all your high-interest rate debt? Do you have an emergency fund in place and are you consistently saving for your own retirement? Do you have the appropriate amount of term life insurance in place to sustain your family if needed? If the answer is no, resolve these tasks first before worrying about your child’s eventual financial obligations. Do not neglect your own financial plan to set your children up for success. Just as a flight attendant reminds you to fasten your own oxygen mask before helping others in the case of an emergency, the best thing you can do for your children is to take care of yourself first. Invest in yourself and your own future so that you are not a burden to your children later.

Now if the rest of your financial plan is indeed on track, there are a lot of options to consider for your kids. It is easy to become overwhelmed by choices and many of them come with unique rules and strict guidelines for accessing your savings in the future. As with any investment decision, the first step should be to determine the purpose of your investment and the timeline to maturity. With young kids, this can be hard to do! Unlike most financial advisors, I am not a fan of education savings accounts (like a 529 plan) for this very reason. Though they may offer tax incentives, they restrict the money you are saving for only one intended purpose years down the road. Speaking from experience, I am one of three kids and the only one who followed the traditional college path timeline. This is only one of the many reasons that there is a huge benefit to investing for your kid’s success in a more flexible format. A Minor Roth IRA or a custodial minor account (called UTMA or UGMA) are great options to consider that can offer the flexibility you are looking for.

A Minor Roth IRA is a retirement account to benefit anyone under the age of 18. Roth IRAs are great for young investors in general because the account owner benefits from tax free growth over their entire lifetime. Uniquely, a Minor Roth IRA requires the child have some form of earned income. This can include an after-school job, allowance paid for mowing the lawn, or doing odd jobs in the family business. A parent or other trusted individual is named as the custodian of the account until the child reaches age of majority at 18 years old. Then the account transitions to an independently owned Roth IRA and continues to grow tax-free. Though these funds are invested with a 40+ year time horizon, the account owner can withdraw any contribution made to the account at any time without penalty or tax due. In this way, a Roth IRA offers your child flexible funds to use in more ways than one if needed.

Similarly, a custodial minor account is a great way to earmark money for your child with limited restrictions. This account is comparable to a traditional brokerage account, but with the protection of naming a custodian of the assets until your child reaches the age of majority. A Uniform Gift or Transfer to Minors Account (UGMA or UTMA) is the most common way to do this. Anyone can contribute to this kind of account, and the custodian can make withdrawals to benefit the child in any way (not just limited to education expenses like a 529 plan). Unlike the Minor Roth IRA, this account can generate taxable earnings that must be reported. With the right investments, you can manage the tax liability on a UGMA/UTMA account to minimize this impact. Also, because these accounts are technically owned by the minor, assets held in a UGMA/UTMA account may count against them when applying for educational assistance or student aid. These are some of the details to consider when selecting the right account vehicle for your child.

As a parent, you ultimately want to do everything you can to support your children. Setting aside money to invest early on can have a huge impact on your child’s life later. However, having conversations with them about money, teaching them how to save, and instilling values like discipline and patience are just as important. Include them in the dialogue and invest in their financial education. Doing so will set them up for success in life with a far greater return than any investment in the stock market ever will.

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