Retired And Investing For Your Children: A Guide To Long-Term Planning

Investing for your children's future is a great way to give them a head start on their financial journey. Whether you want to help them save for retirement, pay for college, or achieve other financial milestones, there are several investment options available. It's important to ensure your own finances are in order before investing on your children's behalf. Here are some popular investment accounts to consider:

- Education Savings Accounts (ESA): Similar to an IRA, ESAs offer tax advantages and allow you to save up to $2,000 per year, per child, for education expenses.

- 529 Plans: These investment accounts offer tax breaks and can be used for qualified educational expenses. There are no contribution limits, and anyone can open and contribute to a 529 plan.

- Custodial Roth IRA: If your child has earned income, they may qualify for a custodial Roth IRA. You can manage the account until your child reaches the age of majority (18 or 21 in most states). Contributions grow tax-free, and your child can use them for major expenses or qualified education expenses.

- UGMA/UTMA Custodial Accounts: These are types of custodial trust accounts that can be opened by a parent or relative on behalf of a child. The funds can be used for various purposes beyond education and offer some tax advantages.

- Brokerage Account: You can open a brokerage account in your name and invest until you're ready to gift the money to your children. This option provides more control and flexibility but doesn't offer the same tax benefits as some other accounts.

Custodial Roth IRA

A Custodial Roth IRA is a tax-advantaged retirement account that is owned by a minor but controlled and funded by an adult custodian. It is similar to a typical Roth IRA but is intended for children, so the account offers some flexibility.

Rules

There is no age limit for a Custodial Roth IRA, but there is a requirement for earned income. If a child has earned income from a part-time job, they may qualify for a Custodial Roth IRA. Earned income is defined by the IRS as taxable income and wages from a W-2 job or self-employment. The Roth IRA contribution limit is $7,000 in 2024 or the total of earned income for the year, whichever is less.

Opening an Account

To open a Custodial Roth IRA, an adult will need to help set up and manage the account. When choosing a provider, consider the fund fees or management fees. You can set up an account online, but you will need to provide Social Security numbers and birth dates for both you and your child, as well as other personal information.

Benefits

A Custodial Roth IRA is a good choice for children because contributions can be withdrawn at any time without penalty. Additionally, there is more time for the account to grow, and children have decades for their contributions to grow tax-free. The tax advantages are also prime for kids, as they have a long time horizon and a low tax rate. Finally, the money in the account can be used for more than just retirement. For example, after the account has been funded for five years, the child can take out up to $10,000 in earnings to buy a first home, tax- and penalty-free.

529 Education Savings Plans

Prepaid tuition plans allow you to buy college credits for the future at today's prices. This way, you can lock in the current rates and avoid potential tuition fee hikes in the future.

On the other hand, education savings accounts let you build a balance and invest your money in the market. Your investments grow tax-free, and you can make tax-free withdrawals for education expenses such as tuition, room and board, textbooks, computers, and other required supplies.

The 529 plan has a minimal effect on financial aid eligibility. It is considered an asset of the account owner (usually the parent) rather than the beneficiary, which has a smaller impact on financial aid. Additionally, contributions up to a certain amount are not subject to federal gift tax.

There are a few things to keep in mind, however. While there are no annual contribution limits, there are aggregate contribution limits that vary by state, ranging from $235,000 to over $550,000. Additionally, contributions over the annual gift tax exclusion amount will count against your lifetime estate and gift tax exemption.

With a 529 plan, you can save for your child's future education expenses while taking advantage of tax benefits and maintaining control over the funds.

Coverdell Education Savings Accounts

A Coverdell Education Savings Account (ESA) is a trust or custodial account set up in the United States to pay for qualified education expenses for a designated beneficiary. The beneficiary must be under the age of 18 when the account is established, or be a special needs beneficiary. The account must be designated as a Coverdell ESA when it is created, and the document creating and governing the account must be in writing.

The Coverdell ESA is similar to a 529 plan, offering tax-free investment growth and withdrawals when funds are spent on qualified education expenses. However, Coverdell ESAs have a maximum contribution limit of $2,000 per year per beneficiary, and they are only available to families below a specified income level. For single filers, income must be below $95,000 for the full $2,000 contribution, and for joint filers, the limit is $190,000. The contribution limit is lower for higher earners and is phased out for single filers with an income of $110,000 or more, and for joint filers with an income of $220,000 or more.

Withdrawals from Coverdell ESAs are tax-free when used for qualifying education expenses, such as tuition, books, supplies, equipment, academic tutoring, and special needs services. If a distribution exceeds the beneficiary's qualified education expenses, a portion of the earnings is taxable to the beneficiary. The designated beneficiary can receive tax-free distributions until they reach the age of 30, at which point any remaining funds must be distributed. If the beneficiary is a special needs beneficiary, there is no age limit.

Coverdell ESAs can be a great way to save for your child's education, but it's important to be mindful of the income limits and contribution caps. It's also worth noting that the funds must be used for educational purposes, and if your child doesn't go to college, the funds will be distributed to them when they turn 30, and they will be taxed on the amount.

UGMA/UTMA Custodial Accounts

The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfer to Minors Act (UTMA) are state laws that allow for gifts of cash or securities to be given to minors without tax implications, up to gift tax limits. The UGMA is valid in all 50 US states, while the UTMA expands the gifts to include property and other transfers, and has been adopted by all US states except South Carolina and Vermont.

UGMA/UTMA accounts are a flexible option for parents who want to save for their child's future, as the funds can be used for anything, including education, a first car, or a down payment on a home. There are no contribution limits, and anyone can contribute—parents, grandparents, friends, and other family members. However, amounts above $18,000 per year ($36,000 for a married couple filing jointly) will incur federal gift tax.

The custodian of the account can invest the money in stocks, bonds, or mutual funds to grow the account balance. When the child reaches the age of majority, they gain full control of the assets and can use them for any purpose they choose. While this can be a significant benefit to the child, it also means that the custodian has little control over how the money is used once the account is transferred.

It's important to note that UGMA/UTMA accounts can impact financial aid eligibility when applying to college. The assets in the account are considered property of the minor, and this can reduce their eligibility for aid by 20% of the account's asset value.

Overall, UGMA/UTMA Custodial Accounts offer a straightforward way to save and invest money for a child, providing flexibility and the potential for significant growth. However, it's essential to consider the potential impact on financial aid and the fact that the child will have full control of the assets once they reach the age of majority.

Brokerage Account

If you want to retain control of your investments for your children, a brokerage account in your name is a good option. You can invest in a variety of assets, including stocks, bonds, mutual funds, and ETFs, and you have the flexibility to choose your investments and withdraw funds without penalty. However, you will have to pay capital gains taxes based on your tax rate, and these accounts do not have the tax advantages of retirement or education savings accounts.

Some brokers offer accounts specifically designed for teens, giving them a sense of ownership and control. For example, Fidelity offers a Youth Account for 13- to 17-year-olds, which lets teens control the account but allows parents to monitor its activity.

If you are considering a brokerage account for your child, it is important to shop around and consider the fees, investment options, and educational resources offered by different brokers. You will also need to provide personal and banking information to open the account.

Custodial brokerage accounts are another option, where you, as the custodian, manage the account until your child reaches the legal age of majority (usually 18 or 21). These accounts allow minors to own assets, and any capital gains are taxed in the child's name. UGMA and UTMA accounts are types of custodial accounts with some differences in what assets they can hold.

Whether you open a standard brokerage account or a custodial account, involving your children in the process can be a great way to educate them about investing and financial planning.

Frequently asked questions