Where do you even start?
By Dalia Rodrigez
When it comes to investing in your child’s future, there are several options available. When choosing an investment account, it’s essential to consider your goals and the child’s needs while considering the potential risks and benefits. It’s also a good idea to speak with a financial advisor, if possible, who can help you make the best decision for your family.
Custodial Accounts
These accounts allow a minor to own and manage assets while an adult (the custodian) oversees the account until the minor reaches the age of majority in their state. There are two main types of custodial accounts: The Uniform Transfers to Minors Act (UTMA) accounts and the Uniform Gifts to Minors Act (UGMA).
Both allow minors to receive gifts, such as money, stocks, and real estate, without the need for a legal guardian or trustee. The assets are held in a custodial account until the minor reaches the age of majority, which varies by state.
When deciding between a UGMA and UTMA account, it’s important to consider:
Flexibility
These accounts offer flexibility when it comes to what assets can be held in the account, as well as when and how they can be used. There are no limits on contribution income or withdrawal.
Type of Assets
UGMA accounts only allow financial assets, while UTMA accounts can hold various assets, such as patents and royalties.
Holding Period
UTMA accounts have a longer holding period, allowing the assets to remain in the custodial account until the minor reaches the age of 21 in some states.
Tax implications
It’s important to note that these accounts are considered the minor’s property. As such, any income or gains the account generates are typically subject to the minor’s tax rate.
Irrevocability
Once the minor reaches the age of majority, they have full control over the account and can use the funds as they see fit, which may not align with your goals for the account.
Financial Aid
UGMA and UTMA accounts can have an impact on eligibility. Since these accounts are considered minors’ property, they can be counted as assets when determining financial need.
Other options to invest for your child’s future include education-only accounts. These accounts are a great tool for families who want to save specifically for education-related expenses. The 529 Plan and Coverdell Education Savings Account (ESA) are popular education savings accounts offering tax-free investment growth and withdrawals for qualified educational expenses. However, you should consider other factors, such as income, contribution, and distribution restrictions for Coverdell accounts. Similarly, the qualified allowed expenses you can cover for k-12 education with 529 plans.
What Happens if Your Child Decides Not To Pursue Traditional Education?
- You can transfer the funds to another family member’s education savings account.
- Use the funds for non-education-related expenses. However, remember that if you withdraw the funds for non-qualified expenses, you may be subject to taxes and penalties.
- The Secure Act 2.0 provides additional flexibility in how to save for education expenses and retirement, allowing for a limited rollover from a 529 education savings plan into a Roth IRA.
Regardless of the type of investment account you choose, starting to invest early for your child’s future is crucial. Even small contributions made regularly over time can add up significantly and make a big difference in the long run.
