As a parent, I want the best for my three boys. I want to do everything I can to set them up for success. I know you want the same for your kids too!
I’ve spoken with many parents and grandparents who have one simple question: How can I invest in my child or grandchild’s future?
Knowing the power of compound interest, one couple told me they wanted to kick-start their son’s retirement savings. Others just want to help their kids get a college diploma without taking on any debt.
Those are great concerns to have, so give yourself a high five! Whether Junior is still crawling around the living room floor or getting ready to graduate from high school, there are plenty of ways you can invest in the future.
Let’s break it all down.
Before You Start Investing for Your Kids
I know you’re eager to dive in, but we need to pump the brakes for just a second. There’s one ground rule I want you to follow. Ready? Here it is:
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Make sure you’re taking care of yourself before you start investing for your children or grandchildren. That means you’re completely out of debt with a fully-funded emergency fund and you’re investing 15% of your income for retirement.
I want you to hear me loud and clear here: Do not start investing for your child if you have to stop investing for your own retirement. You need to be prepared financially so you don’t end up depending on your children during your retirement years. You’ve heard me say this before, but I’ll say it again: Put the oxygen mask on yourself first, before trying to help out your kids.
Now that we got that out of the way, we can take a look at how to invest in your child’s future.
Investing for Your Child’s College Education
A recent survey shows that 74% of Americans saddled with student loan debt wish they could hit the rewind button and do things differently.(1) If you’re interested in saving for your kid’s college so they don’t experience the same frustration, you have some tax-advantaged college savings options similar to your retirement accounts.
An Education Savings Account (ESA or Coverdell Savings Account) is a great place to start! They’re simple and are similar to an IRA, but there are a couple limitations. First, the maximum you can invest in an ESA is $2,000 a year. And second, married couples making more than $190,000 a year and single parents bringing in more than $95,000 a year can’t make contributions to an ESA.
If you want to invest beyond the $2,000 limit or if your income exceeds the ESA income limits, you can put some extra dollars in a state-specific 529 plan.
Saving for your kids’ college fund and making sure they make a smart school choice can help them avoid a future filled with student loan payments. They’ll thank you later!
Investing for Your Child’s Future Retirement
Some of you are thinking much further ahead and wondering how you can give your kids a head start when it comes to retirement. That’s great! It’s never too early to begin saving for retirement. If your child has a part-time job, they don’t have to wait until they have a full-time job or are out of college to get started.
If your teenager is making some money delivering pizzas or mowing lawns, you could open a Custodial IRA in their name, but you would manage the account until they’re either 18 or 21, depending on what state you’re in. With a Custodial IRA, you can open a traditional or Roth IRA, but I recommend choosing the Roth. That way, their retirement savings will grow tax free.
Now, your child must bring in some kind of earned income in order for you to be able to open an IRA in their name, and allowances don’t count! Plus, they can’t contribute more than what they make that year. So if your teenager makes $1,000 as a tutor this year, they can’t put more than $1,000 in their Custodial IRA. But don’t underestimate the power of small contributions.
Setting just a few dollars aside each month can help your teen get a jump start on their retirement savings and experience the power of compound interest!
|Age||Money Invested||Account Balance|
|21–Contributions to the Custodial IRA stop when your child reaches age 21.||$0||$18,414|
|60||$0||$1,078,364–Your child could reach millionaire status at age 60!|
|Retirement||Total Amount Invested||Total Account Balance|
Let’s say you want to open up a Custodial Roth IRA for your 16-year-old daughter who is making bank babysitting on the weekends to earn some cash. She wants to put some of her earnings into the Roth, and you agree to “match” up to $100 each month. (Remember, she can’t put in more than she’s making, so she’s bringing in at least $200 a month.) So when your daughter invests $100 into the account, you also put in $100. That means $2,400 will go into her Custodial IRA each year from age 16–17.
You both put in $100 every month for five years until she turns 21 and the account transfers to her completely. With an average annual rate of return between 10–12%, there will be $16,590 in the Roth IRA when she takes over the account.
What would happen if your daughter just let the account sit there and didn’t put in another dime? Well, if the mutual funds in the account continued to grow at the same rate of return, there would be $1,637,000 waiting for her when she retires at age 65!
And since you chose the Roth IRA, which grows tax free, she won’t be taxed when she takes money out of the account. If that doesn’t get you fired up, then you don’t have a pulse!
Investing for Your Child’s Future Expenses and Experiences
Maybe you’re thinking about investing for things that aren’t too far into the future. After all, your children will go through a lot of important—and expensive—events and milestones in their 20s and 30s.
If you want to save or invest money to help your child out with adult expenses or a down payment on their first house, you’ll want to put that money in an account that’s a little more liquid (or accessible) than a Roth IRA.
While you won’t have the power of several decades of compound interest to follow your kids into their retirement years with these options, they will have access to the funds when they get to those major life events.
1. Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA)
If the account you want to open for your child is one you’re not planning to touch for five years or more, you can consider a Uniform Gifts to Minors Act (UGMA) or a Uniform Transfers to Minor Act (UTMA) account to invest in good growth stock mutual funds. Here are some of the key things you need to know about these accounts:
- Just like with a Custodial IRA, UGMA and UTMA accounts are opened in a child’s name and a custodian is named—usually a parent or grandparent. But you can choose anyone to manage the account.
- The custodian will have full control of the account until the child reaches a certain age.
- UGMA and UTMA accounts are often used to save for college—after ESAs and 529s—but the money can be used for anything.
- There are some tax advantages to using UGMA and UTMA accounts. Since they are in your child’s name, the accounts will be taxed according to their tax bracket. The lower tax rate for children means they’ll pay less in income taxes.
- There are no contribution limits on UGMA and UTMA accounts.
You probably have some thoughts on how you want your kids to spend the money you’re investing for them. Well listen up: Once your child is old enough to take custody of the account, they can do what they want with the money. This may be fine with you, but make sure you’re teaching Junior good financial habits so they’ll be prepared when they inherit the account.
Remember, more is caught than taught.
2. Money Market Account
If the idea of basically handing your kids a blank check makes you nervous, you can open a money market account in your own name and save over time until you’re ready to gift the money in the account to your kids. Technically this isn’t investing, but money market accounts are really great for short-term savings goals (as in five years or less).
They have low interest rates, so your return won’t be much, but you will be in control of when and how your kids receive the money you plan to gift them.
Investing in Your Child: One Last Thing You Should Know
No matter how you plan on investing for your child’s future, it’s important to sit down with your kids when they’re old enough and share your heart behind your gift. Clear communication about the expectations for this money can save you from dealing with family drama around the dinner table during Thanksgiving!
In my book Retire Inspired, I explain that your greatest gift to your children and grandchildren will be what you leave in them, not what you leave to them. Investing in your kids is not just about what you give them, but who they become.
Giving an immature high school or college grad access to thousands of dollars is like handing over the keys of a Ferrari to someone who just passed their driver’s test yesterday. You’re setting them up for a nasty crash!
If you want your financial gift to be a blessing and not a curse, make sure you’re teaching your kids the value of hard work and responsibility. They should have the character, maturity and wisdom to be a good steward of the financial gifts you are entrusting to them.
If you’re excited about wealth building and teaching your kids to start early—and I want you to be!—check out my new book, Everyday Millionaires: How Ordinary People Built Extraordinary Wealth—And How You Can Too.
Work With an Investing Pro
Ready to start investing for your kid’s future? Get the help of an experienced investing professional to walk you through all the options. Our SmartVestor program can connect you with a trustworthy pro who can help you reach your investing goals.