Investing For Your Child's Future: A Million-Dollar Guide

Investing for your children's future is a powerful way to set them up for success and financial freedom. Starting early with financial literacy and investing can give your child a strong foundation for their future, and there are several types of investment accounts that can help you achieve this. Here's an overview of how to make your child a millionaire by investing:

- Start Early: Time is one of the biggest advantages young investors have. The power of compound interest means that even small contributions can grow significantly over time. The earlier you start, the more time your child's investments have to grow.

- Choose the Right Investment Account: There are several types of investment accounts available for children, including 529 plans, Custodial IRAs, Roth IRAs, UTMA/UGMA accounts, and taxable brokerage accounts. Each has its own benefits, tax implications, and restrictions, so it's important to understand them before deciding.

- Teach Financial Literacy: Involve your children in family financial decisions and teach them basic financial concepts like risk vs. reward, stocks, and bonds. This will help them develop crucial money management skills and a healthy attitude towards finances.

- Encourage Diversification: Help your child diversify their portfolio by investing in a mix of stocks, bonds, mutual funds, index funds, and exchange-traded funds (ETFs). This reduces risk and potentially increases returns.

- Monitor and Adjust: Investing is a continuous journey that requires monitoring and adjustments. Stay informed about market trends and economic changes that may impact your child's investments.

- Seek Professional Advice: Consult tax experts and financial advisors to ensure you comply with tax regulations and make informed decisions about your child's investments.

Open a custodial brokerage account

Opening a custodial brokerage account is a great way to set your child up for financial success in the future. A custodial account is a specific type of financial account that is established on behalf of a child and managed by an adult. The account will initially be in the adult's name, but the child will automatically gain full control once they reach the age of majority, which is typically 18 or 21 years old, depending on the state.

Custodial accounts are often referred to as UTMA (Uniform Transfers to Minors Act) or UGMA (Uniform Gifts to Minors Act) accounts. These accounts allow your child to own a diverse range of assets, including stocks, bonds, index funds, cash, insurance policies, and even real estate or fine art in the case of UTMA accounts.

• Choose the right broker: Select a broker that offers custodial accounts with no account fees and no minimum initial deposit. Look for brokers that offer a wide range of investment options, such as individual stocks, mutual funds, index funds, and exchange-traded funds (ETFs). Some recommended brokers for custodial accounts include Charles Schwab, Interactive Brokers, E*TRADE, Vanguard, and Fidelity.
• Gather required information: To open the account, you will typically need to provide your and your child's Social Security number, dates of birth, and contact information. It is also essential to have another bank or brokerage account ready for linking and funding the new custodial account.
• Understand tax implications: It is important to be aware of the tax consequences associated with custodial accounts. Any unearned investment income above a certain threshold ($2,500 for 2023) will be taxed at the child's tax rate, and any amount above the next threshold ($2,600 for 2023) will be taxed at the parent's or guardian's tax rate.
• Help your child choose investments: Once the account is open and funded, you can start investing. Consider a two-pronged approach: help your child pick a few individual stocks of household names they are familiar with, and then build the rest of the portfolio with low-cost index funds or ETFs for diversification.
• Monitor and discuss investments: Regularly check your child's earnings and losses to spark discussion and educate them about investing. Compare the small fluctuations with the more significant long-term changes shown on quarterly statements.

By opening a custodial brokerage account, you can give your child a head start in building their financial future and teach them valuable lessons about investing and money management.

Start a retirement account

Starting a retirement account for your child is a great way to teach them about investing and give them a head start on their financial journey. Here are some detailed instructions on how to start a retirement account for your child:

Types of Retirement Accounts

There are two main types of retirement accounts that you can open for your child: a custodial brokerage account or a custodial Roth IRA account. Let's explore the differences between these two options:

• Custodial Brokerage Account: This type of account is like a piggy bank on steroids! It allows your child to own and invest in various assets such as stocks, bonds, index funds, cash, insurance policies, and even real estate or fine art. UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) are laws that help set up these accounts for minors. You can open a custodial brokerage account with companies like Fidelity or Vanguard.
• Custodial Roth IRA Account: A Roth IRA is a unique retirement account that offers tax-free growth on your earnings. The catch is that your child must have earned, verifiable income to open this account. If your child has a part-time job or earns income through your business, you can open a custodial Roth IRA with companies like Fidelity, Vanguard, or Charles Schwab.

Funding the Retirement Account

Now that you've chosen the type of retirement account, it's time to start contributing funds. Both the custodial brokerage account and the Roth IRA account require your child to have earned income. This can include money from a part-time job, self-employment gigs like babysitting or lawn mowing, or even income from modelling. It's important to keep records or receipts for any income earned, especially if your child doesn't receive a W-2 or 1099 form.

Contribution Limits

It's important to be mindful of contribution limits when funding your child's retirement account. For 2024 and 2025, the maximum your child can contribute to either a traditional IRA or a Roth IRA is $7,000 per year or their total taxable earned income for the year, whichever is less. For example, if your child earns $5,000 in a year, they can contribute up to $5,000 to their IRA.

Managing the Account

As the parent or guardian, you will typically be the custodian of your child's retirement account until they reach the age of majority, which is usually 18 or 21 depending on your state. During this time, you will control the assets in the account and make all investment decisions. Once your child reaches the required age, the assets must be transferred to them, and they will have full legal rights over the account.

Benefits of Starting Early

Starting a retirement account for your child has numerous benefits. First, it teaches them valuable financial lessons about investing, saving, and managing their money. Additionally, the power of compound interest is maximized when they start investing at a young age. Even small contributions can grow significantly over time, setting your child up for a comfortable retirement.

Teach your child about financial literacy

Financial literacy is the ability to understand and manage one's finances effectively. Teaching your child about financial literacy can empower them to make informed decisions about money and investing. Here are some ways to help your child develop financial literacy:

• Start early: The earlier you start teaching your child about money, the better. Even young children can begin to understand basic financial concepts.
• Make it practical: Use everyday situations to teach your child about money. For example, when grocery shopping, explain the cost of different items and help them understand the concept of value.
• Involve them in family finances: Include your child in family budgeting discussions, saving for a family goal, or even managing their own allowance. This will help them understand the importance of financial responsibility.
• Teach them about risk and reward: Explain the relationship between risk and reward when investing. Discuss the difference between high-risk, high-return investments like stocks and low-risk, low-return investments like bonds.
• Open a savings account: A savings account can be a great way to introduce your child to the basics of banking and financial management.
• Encourage them to invest: Once your child has a basic understanding of investing, encourage them to put their money to work. Help them research and choose age-appropriate investments like stocks, bonds, or mutual funds.
• Use technology: Utilize technology, such as online tutorials, practice accounts, and investment simulations, to help your child learn about investing in a safe and engaging way.
• Lead by example: Be a role model for your child by managing your own finances wisely. Show them how you make financial decisions and involve them in the process.
• Discuss current events: Use real-world examples, such as news stories about the stock market or cryptocurrency, to illustrate the impact of financial decisions.
• Emphasize the importance of financial independence: Help your child understand the value of money and the importance of managing it effectively. Teach them about budgeting, saving, and investing for the future.
• Teach them about taxes: Explain how taxes work and how they will impact your child's investments or earnings. This will help them make informed decisions and avoid surprises later on.

Explain the risk and reward of stocks and bonds

Investing is a great way to build wealth for your child's future. While there are many types of investments, stocks and bonds are two of the most common. Here is an explanation of the risk and reward of stocks and bonds to help you make informed decisions about investing for your child's future.

Stocks

Stocks are considered high-risk investments, but they also offer the potential for high returns. The value of a stock can fluctuate due to various factors, such as company growth, profitability, and negative news. While it is challenging to predict the impact of associated risks, the stock market has consistently risen over the last hundred years, offering solid returns.

One way to assess the risk of a stock investment is by using beta, which measures the correlation of a stock with a market benchmark, such as the S&P 500 Index. High-beta stocks are more volatile than the broader market, while low-beta stocks exhibit less volatility.

Stocks provide partial ownership of a company, and their performance is linked to the company's performance. A well-timed stock investment can accumulate generational wealth, but it is important to remember that stocks are more volatile than bonds and can experience dramatic losses.

Bonds

Bonds, on the other hand, are considered low-risk, low-return investments. When you buy a bond, you are essentially loaning money to a company or government entity for an agreed-upon period and interest rate. Bond investors know exactly how much they will earn, as it is based on the interest rate and maturity date.

Bonds are typically more stable than stocks during economic uncertainty, but they have much lower ceilings in terms of returns. It is challenging to find bonds that have doubled in value over a few years, unlike stocks.

Bonds also carry the risk of default, which is the possibility that the issuer may be unable to meet its obligations, such as paying interest or returning the principal amount.

Diversification

When investing for your child's future, it is essential to consider diversifying your portfolio with a mix of stocks and bonds. Diversification helps spread risk and mitigate overall portfolio risk. A common strategy is to allocate a certain percentage to stocks and another to bonds, depending on your risk tolerance.

By understanding the risks and rewards associated with stocks and bonds, you can make more informed investment decisions to help your child become a millionaire in the future.

Discuss the benefits of a Roth IRA

Investing in a Roth IRA is a great way to make your child a millionaire. Here are some of the benefits of a Roth IRA:

Tax-Free Growth

Roth IRAs are funded with after-tax money, meaning your contributions grow tax-free. This is particularly beneficial for younger investors, who are likely to be in a lower tax bracket than when they retire.

Tax-Free Withdrawals

Account holders can withdraw their contributions at any time without incurring taxes or penalties. Withdrawals of earnings are also tax-free, as long as the account has been open for at least five years and the account holder is at least 59 and a half years old.

No Required Minimum Distributions

Roth IRAs do not have required minimum distributions (RMDs), which can be beneficial during a down market. This also allows you to pass on more of your savings to your heirs.

Pass Down to Heirs

Beneficiaries of an inherited IRA receive tax-free withdrawals if the account has been open for at least five years. This allows you to pass on your wealth to the next generation without burdening them with taxes.

Tax Flexibility in Retirement

Since you've already paid taxes on your contributions, you can withdraw your money tax-free in retirement. This allows you to better manage your overall income tax liability by strategically choosing which accounts to withdraw from.

Hedge Against Future Tax Hikes

While we can't predict future tax rates, a Roth IRA can provide some protection against potential tax increases. Contributing now at a lower tax rate means you can take advantage of tax-free withdrawals in the future, even if tax rates rise.

Use Your Contributions at Any Time

A Roth IRA gives you access to your contributions at any time, for any reason, without taxes or penalties. This flexibility can be valuable if you need to access your funds for unexpected expenses.

No Age Requirement for Contributions

As long as you have earned compensation, you can contribute to a Roth IRA at any age. This means you can continue to build your retirement savings even after traditional retirement age.

Higher Income in Retirement

If you're just starting your career, your income is likely to be higher by the time you retire. A Roth IRA can be advantageous in this situation, as you'll benefit from tax-free growth and withdrawals at a potentially higher tax bracket.

By taking advantage of the benefits of a Roth IRA, you can set your child up for financial success and help them become millionaires by the time they retire.

Frequently asked questions