By Haley Tolitsky, CFP
One of the best ways to set your children up for success is to start saving for their future now. It’s incredibly beneficial to invest at a young age because they have time on their side, meaning compounding interest has plenty of time to do its job. Whether your goals are to save for their education, future expenses like a down payment on a house, or even for their retirement, there is an investment vehicle for you. Whether you have a teenager, toddler, or are expecting, educating yourself on the different types of investment accounts and getting started now can make a tremendous impact on their future. Here are three accounts to consider:
529 plans are a powerful tool to save for a child’s college costs. The funds in the account grow tax-deferred, and no taxes are due on withdrawals when used for qualified education expenses, including tuition, housing, and supplies. Qualified educational expenses also include trade schools and up to $10,000 per year for K-12 tuition and $10,000 in student loan repayments.
The parent retains ownership of the account, meaning the beneficiary can be transferred to another sibling or family member if that child does not go to college or use all of the funds in the account. 49 states and the District of Columbia offer at least one 529 plan, but you do not have to use your state-specific plan. Review the plan’s investment options and expenses. Also, see if your state offers a tax deduction or credit for 529 contributions before deciding on a provider.
Anyone can contribute to your child’s 529 plan, making it a great gift idea. There are no annual limits, but contributions are considered gifts for tax purposes. Each donor will likely not want to contribute more than $16,000 per year (2022) to stay under the annual gift tax exclusion amount. A larger lump sum contribution can be made under the assumption that it covers the next 5 years of contributions, ex. $80,000 in 2022.
A custodial account is a great way to save for your child’s future that does not require the funds to solely be used for educational costs, although it does not have the tax benefits and control that a 529 plan has. It’s important to know that the ownership of the account will transfer to the child at the legal age of adulthood, 18 or 21 depending on the state, so the donor no longer will have control of the funds or how the recipient spends them. If the beneficiary decides to buy a new car and travel with the account funds instead of going to school, the donor cannot stop them.
Gifts can be in cash or investments such as stocks, bonds, and mutual funds. There are no contribution limits, but gifts into the account are irrevocable. Assets in a student’s custodial account will reduce their eligibility for need-based financial aid for FAFSA®.
Custodial Roth IRA
Starting a Roth IRA for a child under 18 can jumpstart a minor’s savings for retirement, providing decades of tax-free growth and future tax-free distributions. Roth IRA owners are able to take their contributions out at any time without taxes or penalties, and distributions taken after age 59 ½ or for qualifying events, such as up to $10,000 for a first-time home purchase, are tax-free.
The key is that the minor must have earned income, either from a job or self-employment, to contribute to the Roth IRA, making this a great option for children that have summer jobs or work for the family business. In 2022, the maximum contribution is the lesser of the child’s total earned income, or $6,000. Like a custodial account, the adult maintains ownership of the account until the child turns 18 or 21.
Although a child may not fully understand the impact of your current contributions, investing now can make a huge difference in their financial future. Start by deciding your goals with the money you are investing – for college, other expenses, or just to help your child get ahead – and encourage other family members to participate in lieu of or in addition to gifts that a child will only use for a short time. By understanding the different types of accounts available, you can make the best decision for your family, and if you are not sure, reach out to a financial advisor who can explain the benefits and drawbacks of each in further detail.
About the Author: Haley Tolitsky, CFP®
Haley Tolitsky, CFP®, is a CERTIFIED FINANCIAL PLANNER™ with Cooke Capital in Wilmington, NC, providing highly personalized financial planning and investment management services. She is passionate about financial empowerment, specifically for women and the next generation, and loves the opportunity to motivate and guide others to take charge of their financial lives. Haley can be reached at email@example.com.
Securities offered through The Strategic Financial Alliance, Inc. (SFA), Member FINRA, SIPC. Advisory services offered through Allegiance Financial Group Advisory Services, LLC (AFGAS). SFA, AFGAS, and Cooke Capital, Inc. are not affiliated. Supervising office: 678-954-4000. Allegiance Financial Group Advisory Services, LLC (AFGAS) is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.