Your kids will likely be exposed to money at a young age, either from allowances, visits from the tooth fairy, or monetary birthday gifts. Today, we delve into the topic of investing for kids.
Teaching kids about finances and investing is an essential tool that every parent should give their child well before sending them off on their own.
According to Next Gen Personal Finance, as of 2020, a mere 18.4% of high school graduates had taken a course on personal finance. Also in 2020, the CEE (Council for Economic Education) recorded only 21 states that currently require students to take a personal finance class in high school, reports MoneyRates.
In most cases, the responsibility will fall on the parents to talk to children about how to handle money and investing.
But how do you start investing for kids? Where do you put their money? How can it be tax-exempt until or when they need it?
These are all questions that can lead to an organized and methodical approach to helping your kids start investing early for financial success later.
How to Talk Finances With Kids
A child’s favorite question is ‘Why?’ So having a perfect answer for them when you suggest investing their money is extremely important. There are special ways to talk to your child about finances that won’t put them to sleep.
Because technology tends to make things more appealing to kids of all ages, this might be a good time to find some great online educational resources.
Modern-day programs that will get kids of all ages thinking and engaging in finances are aplenty and might even teach adults a thing or two as well.
Excellent Resources for Introduction to Finances
From government websites to public broadcasting shows, the resources available for kids to learn finances are abundant.
No matter how your child learns best, these resources have thought of it all including games to make practicing fun, lessons to challenge older kids, and shows that capture real-life scenarios of finances among kids.
One such resource is the government website TreasuryDirect Kids. They offer educational programs and finance sections for elementary and middle school children. Featuring educational games and organized lessons, the site will certainly instruct the youth on responsible ways of handling money.
University websites, particularly those with renowned business schools, also feature outstanding resources. The University of Penn has a school of business that fuels a website geared towards the financial education of high-school children.
It offers simplified explanations of complex financial concepts. In addition, there is access to an FAQ section where kids can talk to a professor about anything they want to know financially.
If your child is considering attending college, it is particularly important to teach them about the finances that are involved in borrowing student loans. The National Endowment for Financial Education has a website called, My Bread, that educates teens on saving for college and how to make your money go further.
There cannot be enough emphasis on educating high-schoolers on the financial cost and potential future burden of continuing education, especially with the rising costs of universities and colleges.
Talking about investments with your child could also open the conversation about money-saving approaches to attaining a college degree or licensure in a trade.
How to Start Your Child With Investing
Now that you’ve got ways to talk to your child about financial investing, let’s look into the mechanics of investing for kids. Because children (also referred to as minors) cannot legally sign contracts, it is important to note that a trusted adult has to be the custodian of the account until the minor reaches maturity (different age in every state).
The government has established a means for investing for a child under the Uniform Transfers to Minors Act (UTMA) and the Uniform Gifts to Minors Act(UGMA), says Finaid. These two plans allow a custodian to open and maintain funds for a minor without having the privilege of withdrawals.
When the minor turns the legal state age of an adult, the custodian will be dropped from the account and it will become the child’s to manage. The best 529 savings plan is the UTMA 529 savings plan.
You can open all types of accounts for your child as a custodian. A simple savings account or checking account could be a good place to start your young child to teach simple banking transactions.
Helping your child track deposits and withdrawals with a transaction book can give them a great foundation for account balancing.
As they get slightly older and have a small baby-sitting or pet-walking job, you can help them find a good rate on a certificate of deposit (CD) after they have saved a good lump sum.
These accounts will lock their money away for a specified amount of time at an interest rate that only comes to fruition at the end of the term. These are best utilized during a middle school or early high school age since they will make the funds inaccessible during the term.
Another option could be a custodial brokerage account. These types of accounts function similarly to the brokerage account that you’d manage as an adult. Acorn offers portfolios to help guide custodians and children in opening the best custodial brokerage account for them.
When your child starts making earned income, an IRA might be the best idea for investing for kids. An IRA offers children a fantastic vehicle for growing their money without the heavy tax consequences of other investments.
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Timing Considerations of Investments
First and foremost, time is of the essence. As much as you want your child to invest, don’t give them options that will lock their money away too long.
They will need their savings for a car and a driver’s license, for college, or for certificate courses and licensing for any trades they enter. Short-term investments such as some certificates of deposit are great choices for investments for kids.
If your child is still young, they can open a longer-term investment such as a savings bond or treasury bond that is accessible after ten or twenty years.
These are loans to the government that accrue interest at six month intervals. A unique feature of savings bonds is the ability to sell them before you reach the maturity date.
Considering Tax Consequences on Kids Investments
Next, consider the tax consequences on the investment. The IRS and federal government have changed laws surrounding special college savings plans in recent years. Both the type of plan and the amount of money in the account will determine the tax consequences of the account.
In some cases, the custodian will be taxed on the investment and in other cases, the child will have to file a return and will be taxed at the child’s rate by the IRS. Still other plans are tax-exempt entirely if the funds are used for educational purposes.
Particularly in the last five years, the 529 plans have had some incredible revisions. As a result of the Tax Cut and Jobs Act of 2017, the funds placed in a 529 plan can be used for primary education costs, including private elementary school or high school entirely tax-free.
In addition, if the individual for whom the account is opened, decides they don’t need the funds, the money can be transferred to another child with no tax consequences.
Furthermore, individuals with a 529 plan can use up to $10,000 (lifetime amount) in their fund to repay student loans, says Finra. Just understand that you will not qualify for the student loan interest deduction if you choose to use the money from the plan to pay student loans.
For the UTMAs and UGMAs, you are allowed $1100 per year of unearned income deposits at a zero percent tax rate. The following $1100 per year is subject to a lower tax rate based on children’s income.
Any additional amounts over the $2200 are subject to the custodian’s tax rate. However, the advantage of the UTMAs and UGMAs is the ability to use the funds for things outside of education.
One Final Aspect to Consider
Based on a number of factors, you will want to be conscious of the effect of the investments on your child’s FAFSA as they near college application age. The government continually changes which accounts will impact the access to grants and loans from the FAFSA.
In many cases, it is a matter of who claims the assets and how much the government weighs the assets. This is something that many financial advisors, through whom you open the investments, will have the expertise to advise you on the best case scenario.
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