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Give Your Children (or Grandchildren) a Financial Head Start

Written by Samuel Taube
Posted August 4, 2019

There’s a saying in finance that I quote a bit excessively. I used it in one of my recent articles, and I’m going to use it again today because it’s so darn relevant: Time in the market beats timing the market

In other words, the value of your long-term investments depends more on how long you’ve been investing than on which market-forecasting tricks you try to use. 

A few extra decades in the market can make a monumental difference in long-term financial outcomes. As you can see from the chart below, an investor who put $10,000 in an S&P 500 fund back in 1969 would have more than 15 times as much money today as someone who invested $10,000 in 1999.

financial head start

Most of us start investing after we get our first full-time job (which typically happens between age 18 and 25). That gives us about 40 to 50 years to save and invest for retirement in an ideal scenario. 

But what if you could give your children (or grandchildren) a massive financial head start by beginning their investing career earlier in life? 

What if you could open investment accounts for them in the first couple decades of life, thereby giving them 60 years or more to accumulate wealth before retirement

As a matter of fact, you can. Today we’re going to look at how to open several different kinds of investment accounts for an under-18 dependent.

Opening a Roth IRA for a Child or Grandchild 

The phrase “Roth IRA” is rarely uttered by anyone under age 25, but it’s actually one of the best types of investment accounts to open for your child or grandchild. 

After all, it’s never too early to start saving for retirement. But if your kid is too young to file their own taxes, it is too early for them to take advantage of the upfront tax deductions generated by traditional IRA contributions. 

Roth IRA contributions, on the other hand, aren’t tax deductible, which your kid won’t mind. But withdrawals are tax-free, which your kid will appreciate later in life.

And while these accounts are mainly intended to be retirement savings vehicles, they have other uses. Your kid can withdraw their contributions at any time, and they can use their investment earnings to buy a house or college tuition credits later in life. 

There are a few special rules around Roth IRAs for kids. You must open a custodial Roth IRA account if your child or grandchild is under 18. Not all brokerage firms offer these, but many of the big ones — such as Charles Schwab and Fidelity — do. 

Your child or grandchild must also have earned income to contribute. That income could be from a summer or after-school W-2 job, or from self-employed work like mowing lawns or babysitting. You can “match” their contributions as long as the total contribution amount doesn’t exceed the child or grandchild’s earned income. 

UGMA and UTMA Accounts

If you want to open an investment account for your child or grandchild before they’re old enough to earn income, a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account might be your best bet. 

The UTMA and UGMA are state laws that allow adults to transfer up to $15,000 per year to a custodial account owned by a minor without incurring federal gift tax. Married couples who file taxes jointly can give their children or grandchildren up to $30,000 per year without gift tax. Contributions to these accounts are not tax deductible.  

The UTMA and UGMA are supposed to be uniform across all states (hence the name), but they are state laws and not federal laws. 

Every state has some variant of the UGMA or UTMA, but the specifics may be different depending on where you live. 

South Carolina, for instance, has adopted the UGMA but not the UTMA, which means South Carolinian UGMA account holders are restricted to a narrower set of investments (cash, stocks, bonds, and insurance policies) than UTMA account holders in other states. 

Most major brokerages can help you open UTMA or UGMA accounts for your children or grandchildren. Talk to a financial advisor to learn about the relevant laws and restrictions in your state. 

529 Plans

If you’re particularly interested in helping your child save and invest for college, you should consider opening a 529 plan. These are basically Roth IRAs for your child or grandchild’s education. 

You contribute post-tax dollars to them, they compound tax-free, and then you make tax-free withdrawals from them for qualified education expenses. These include college tuition, textbooks, and even student housing.

They have no age restrictions (as long as the child or grandchild is born and has a name and Social Security number) and are offered by most major brokerages.    

529 plans always remain under the control of the person who opens and funds the account, not the beneficiary. Some states also offer tax benefits to people who contribute to 529 plans. 

These accounts come in two types: prepaid plans and savings plans.

Prepaid plans aren’t really investment accounts, per se — they simply allow plan owners to purchase future tuition credits at today’s cost without worrying about inflation or tuition increases.     

Savings plans, on the other hand, are just like IRAs — they grow the plan owner’s money in the stock market to keep ahead of inflation and tuition increases.

By helping your child or grandchild stash away money for their future, you’ll be giving them an exponential leg up on their peers. 

Whether you open a Roth IRA, UTMA/UGMA account, or 529 plan, you’ll be giving them the most precious gift in the financial world: time

Until next time,

Monica Savaglia

Samuel Taube

Samuel Taube brings years of experience researching ETFs, cryptocurrencies, muni bonds, value stocks, and more to Wealth Daily. He has been writing for investment newsletters since 2013 and has penned articles accurately predicting financial market reactions to Brexit, the election of Donald Trump, and more. Samuel holds a degree in economics from the University of Maryland, and his investment approach focuses on finding undervalued assets at every point in the business cycle and then reaping big returns when they recover. To learn more about Samuel, click here.

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