It’s never too early to start when we’re talking about generational wealth. Investing, which is wealth-building’s greatest tool, is not just for adults. It’s for kids, too. Here is how you can start investing for the kids in your life.
We’re all about generational wealth on this platform. Not only are we trying to build wealth for ourselves, but we also want to pass on financial education and capital to our families, including the children in our lives. But how do we invest for kids? And what should we be asking ourselves?
Investing For Kids: Why Should We Be Doing It?
At its core, these reasons are the same ones as the ones for why you should be investing. Except only magnified. Think about it: if kids start investing now, they have an even larger window to let compound interest do its thing. Depending on the account, we can also provide them with a headstart on retirement. Lastly, it is a great teaching tool as our kids grow up and start handling their own finances.
Here’s What You Need To Think About First
Many of the questions we want our new investors to ask themselves also apply here. Whenever we are investing or opening up a new investing account, we should have a clear goal in mind. That could be a specific number, but perhaps even more important is the outcome or access point you’d like investing to bring you. So before you jump into investing for kids in your life, you need to make sure you have a solid understanding of the end goal, be that college or just an early-start to their retirement fund.
Like any other investor, we also want you to create your contribution schedule. The best kind of investing is one that is consistent. Will you be investing the same amount monthly? Are you investing extra funds in your budget at the end of each month? One-time contribution?
Lastly, give some thought to how you want to incorporate the child themsleves into the process. At what point will they learn of this account in their name? How will you explain to them what this account means? How can we ensure they will be able to leverage this asset to the best of their abilities when it is handed off?
Answering these sets of questions will then allow you to decide which investment account makes the most sense for the child in your life .We’ve pulled out your options:
1. The 529 Plan
You’ve probably heard of this type of account. It was specifically designed for higher education expenses, however now it can be used for some K-12 expenses as well depending on the state. It functions much like a retirement account because it offers tax-free growth and tax-free withdrawals so long as it is used for the child’s education.
What we love about this type of account is that it is easy for anyone else in your family to contribute. Think about it: instead of gifts, people can contribute to the 529 account. If folks have a bit of extra money at the end of the month, you can direct then to contribute to the 529 plan.
Technically, the 529 does not have official contributon limits. However, contributions made to a 529 are limited by the annual federal gift tax exclusion, which in 2022 is $16,000 per donor. Each state offers its own 529, and you are not limited to the state that you are a resident of. And if you’re worried about saving for college for your kid without knowing if they actually want to go, 529 plans are transferable to another child.
2. Custodial Brokerage
If you’re looking for a bit more flexibility in usage, you may want to consider a custodial account. For these accounts, the parent or guardian of the account is the account’s beneficiary– until the child turns 18 or 21, depending on state laws.
Contrary to a 529 where your options are limited, a custodial account offers more variety in terms of investment vehicle: from individual stocks, to ETFs and mutual funds, you have plenty of options. However, this account does not offer the same tax benefits that a 529 plan offers. Any income coming from the investments will be taxed at a child’s tax rate, which sometimes can be as low as 0% up to a certain amount.
With the rise of retail investors, many brokerages have also created account types that are targetted for youth, which will come with unique features that can allow for more participation from the kid. If you already have a preferred brokerage, find out if they offer any accounts for youth.
3. Custodial Roth IRA
You may be familiar with the Roth IRA already. We love them for kids for the same reason that we love them for anyone else: the tax benefits and the variety in investment vehicle options. However, the same limits apply for kids that they do for adults.
This account type is only an option if your child has taxable income or wages. While there are certainly ways that your kids can legally qualify for this through income, typically this won’t happen until 15.5 or 16 when they get their first job. That is still an extra 2 years ahead of 18 that compound interest can do its job. During this stage, this account will function as a custodial account, with full ownership transferring over at the age of 18.
Keep in mind that this is a retirement account. Contributions can be pulled out at any time, and there are stipulations for permissible uses of investment funds. Outside of things like education and a first-home purchase, these funds cannot be used until 59.5, without accruing a penalty fee. So if you are opening up this account type, it is because you are wanting to kickstart this child’s retirement plan.
Make Sure To Teach
Regardless of the account you choose to open, an integral piece of the process needs to be involving the child you are wanting to invest for. In Episode 126 with Kevin L. Matthews II, we discuss the importance of including these kids into the conversation as early as possible. Not only can we begin to ensure there won’t be a misuse of these assets when they are legally handed over, but we are also passing down the financial education that so often is absent from first-gen communities.
Investing for the kids in our lives is not just about building a cash nest-egg for them. It is also about making sure they know how to understand money, how to manage money, and how to grow it efficiently.