You likely already know the importance of investing for retirement.
Without the growth provided by long-term investing, you’ll find it nearly impossible to grow the nest egg you need to be financially dependent in your later years. As hard as contributing to a retirement account can be for investors, your children face an even steeper road to climb to financial independence than you do.
“Inflation over the last 100 years has devalued the dollar and will continue to do so, meaning children today will need a great many more dollars in the future to live on what we do today,” says Mark Charnet, founder and CEO of American Prosperity Group in Pompton Plains, New Jersey. For instance, it takes $10,000 today to buy the same amount of goods you could have bought for $6,455 in 2000, according to the U.S. Bureau of Labor Statistics.
The best way to combat the impacts of inflation is by investing. The earlier you start investing, the better off you’ll be.
“Often referred to as a turbocharge or super-boost, the earlier one starts investing, the more time for compounding’s exponential growth to occur,” says Thomas O’Connor, senior wealth advisor at Keel Point in Huntsville, Alabama. The corollary to this is the earlier you start investing, the less money you’ll actually need to invest to reach a given goal.
“Creating a brokerage account for your child while young could give them a giant head start in life when they reach adulthood,” says Matt Dworetsky, founder of Dworetsky Financial in Manalapan, New Jersey.
In addition to helping provide your children with future financial stability, investing on your children’s behalf can also yield other benefits. “In a world of instant gratification, investing goes against the grain,” O’Connor says. “Investing, by nature, is long term and requires patience and other principles to achieve the desired outcomes.”
Investing for kids and including them in the process can help them learn valuable skills, such as delayed gratification, the habit of saving and the benefit of compounding, he says.
“Involving your kids with the investment process early on will allow them to learn by doing,” says Billy Bruns, wealth specialist and senior associate at MAI Capital Management, LLC in Cincinnati. “Teaching them the steps of choosing an asset allocation, diversifying the investments and rebalancing over time will serve them well as they make these decisions with larger and larger balances as they grow older.”
How to Invest for Your Kids
“There are a myriad of options when investing for your children,” Charnet says. In fact, the options are largely the same as the ones you have when investing for yourself.
If you’re investing for a child’s education, you might use a state-specific 529 account. These allow you to make after-tax contributions to an investment account that can later be used tax-free for qualifying primary or secondary education expenses.
“The primary downfall of a 529 plan is that the funds must be used for educational purposes in the future, and your child may always decide not to pursue a higher education,” Charnet says. “You can transfer the account from child to child for educational purposes, or face penalties and taxes if you use the funds for non-educational reasons.”
The ability to pass 529s down makes them “exceptional legacy accounts as they can be passed down indefinitely with tax-free benefits for education needs,” O’Connor says.
If you want to give your children a leg-up on retirement, you could open a minor Roth IRA. “If you think compounding is impressive, tax-free compounding is on another level,” O’Connor says. There’s one catch — to use a minor Roth IRA, your child must have earned income and you can only contribute as much as they earn in the year up to the annual maximum, which is $6,000 for 2021. So if they earned $1,000 working as a camp counselor, you could put $1,000 into their Roth IRA.
Distributions are then tax-free, although there may be income taxes and penalties if your child withdraws the money before age 59.5 or has not held the account for five years. “However, certain exceptions may apply, such as up to $10,000 for a first home purchase,” O’Connor says.
For a general purpose investment account for your child, consider a Uniform Transfer to Minors Act account, or UTMA account. “Similar to an individual brokerage account, you may be subject to taxes each year depending on dividends and capital gains,” O’Connor says. “However, with a UTMA, taxes are at the child’s tax rate, which is generally less than the parent.”
Note that once your child reaches the age of majority, typically 18 or 21 depending on your state, they become the legal owner of the account and can use the funds as they choose. It’s also possible for your child to sue you for mismanagement of their UTMA account, Charnet says.
If these are a concern, then a better option may be to open a brokerage account in your name and earmark the funds for your child. You’ll have to pay taxes at your tax rates, but you’ll also retain full control over the account and face fewer restrictions than with any of the previously listed options.
“Children can be named successors in the event of the parent’s incapacity or death, and the account can be transferred to the child if the assets are placed in a trust or will by the parents,” Charnet says.
How to Open a Brokerage Account for Your Kids
“Once you decide what type of account is best for your kid’s situation, you then need to decide which financial firm you would like to open the account with,” Bruns says.
Dworetsky recommends using a large custodian such as Fidelity, Charles Schwab or Vanguard, each of which can help you with any account you choose. Simply Google “start a Fidelity brokerage account,” and you’ll find a link to the firm’s website where you can see the different account types, he says.
“From there, you click which account you want to create and follow the steps to create an account on your child’s behalf,” he says. “Depending on the account type you go with, you may need to input your child’s Social Security number as well as birthday and contact information.”
If you’d like help, you can also work with a financial advisor who can walk you through the steps.
“Once the account is opened, you can fund it via check or by linking a bank account to it,” Bruns says. Then it’s time to start investing.
You can get a little more buy-in with the process when investing in companies your child likes, O’Connor says. But while this strategy may stoke engagement, it’s also important to teach your kid about diversification, or not placing all your eggs in one basket. You can do this by adding broadly diversified exchange-traded funds, or ETFs, and mutual funds that will give you access to a basket of securities with each share you buy.
“With funds, you get ease of use, professional management, stated investment objectives, small minimum investment requirements, low costs and fees of operations, and the ability to transfer your funds between other funds in the same family without additional fees or expenses,” Charnet says. “Different funds have different investment objectives, so read and compare.” A fund’s investment objective can be found on its profile page.
“Any reputable brokerage firm will let you open more than one account, which means you should have one for each child,” Charnet adds.
As your child grows, you can involve them in investment decisions and management. “Teaching children about investing and doing it together is a valuable gift and experience parents can provide, instilling important financial and life principles at an early age that sets them up for future success,” O’Connor says.
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