As a parent, you want to do everything you can to set your kids up for success. As a result, you may be asking yourself: How can I invest in my child or grandchild’s future?
Knowing the power of compound interest, some folks may want to know how to kick-start their children’s retirement savings. Others just want to help their kids get a college diploma without taking on any debt.
Those are great concerns to have, so give yourself a high five! Whether Junior is still crawling around the living room floor or getting ready to graduate from high school, there are plenty of ways you can invest in the future.
Let’s take a closer look!
Before You Start Investing for Your Kids
We know you’re eager to dive in, but let’s pump the brakes for just a second. There’s one ground rule you need to follow. Ready? Here it is:
Make sure you’re taking care of yourself before you start investing for your children or grandchildren. That means you’re completely out of debt with a fully funded emergency fund and you’re investing 15% of your income for retirement.Be confident about your retirement. Find an investing pro in your area today.
Hear us loud and clear here: Do not start investing for your child if you have to stop investing for your own retirement. You need to be prepared financially so you don’t end up depending on your children during your retirement years. Put the oxygen mask on yourself first, before trying to help out your kids.
Now that that’s out of the way, let’s take a look at how to invest in your child’s future.
Investing for Your Child’s College Education
A recent survey shows that 84% of millennials are saddled with some sort of regret over their student loan debt, many of them wishing they could hit the rewind button and do things differently.1 If you’re interested in saving for your kids’ college so they don’t experience the same frustration, you have some tax-advantaged college savings options similar to your retirement accounts.
An Education Savings Account (ESA or Coverdell Savings Account) is a great place to start! They’re simple and are similar to an IRA, but there are a couple limitations. First, the maximum you can invest in an ESA is $2,000 a year. And second, married couples making more than $220,000 a year and single parents bringing in more than $110,000 a year can’t make contributions to an ESA.2
If you want to invest beyond the $2,000 limit or if your income exceeds the ESA income limits, you can put some extra dollars in a state-specific 529 plan.
Saving for your kids’ college fund and making sure they make a smart school choice can help them avoid a future filled with student loan payments. They’ll thank you later!
Investing for Your Child’s Future Retirement
Some of you are thinking much further ahead and wondering how you can give your kids a head start when it comes to retirement. That’s great! It’s never too early to begin saving for retirement. If your child has a part-time job, they don’t have to wait until they have a full-time job or are out of college to get started.
If your teenager is making some money delivering pizzas or mowing lawns, you could open a Custodial IRA in their name, but you would manage the account until they’re either 18 or 21, depending on what state you’re in. With a Custodial IRA, you can open a traditional or Roth IRA, but I recommend choosing the Roth. That way, their retirement savings will grow tax-free.
Now, your child must bring in some kind of earned income in order for you to be able to open an IRA in their name, and allowances don’t count! Plus, they can’t contribute more than what they make that year. So if your teenager makes $1,000 as a tutor this year, they can’t put more than $1,000 in their Custodial IRA. But don’t underestimate the power of small contributions.
Setting just a few dollars aside each month can help your teen get a jump start on their retirement savings and experience the power of compound interest!
|Age||Money Invested||Account Balance|
|21–Contributions to the Custodial IRA stop .||$0||$17,743|
|60||$0||$1,269,609–Your child could reach millionaire status.|
|Retirement||Total Amount Invested||Total Account Balance|
Let’s say you want to open up a Custodial Roth IRA for your 16-year-old daughter who is making bank babysitting on the weekends to earn some cash. She wants to put some of her earnings into the Roth, and you agree to “match” up to $100 each month. (Remember, she can’t put in more than she’s making, so she’s bringing in at least $200 a month.) So when your daughter invests $100 into the account, you also put in $100. That means $2,400 will go into her Custodial IRA each year from age 16–17.
You both put in $100 every month for five years until she turns 21 and the account transfers to her completely. With an average annual rate of return of 11%, there will be $15,903 in the Roth IRA when she takes over the account.
What would happen if your daughter just let the account sit there and didn’t put in another dime? Well, if the mutual funds in the account continued to grow at the same rate of return, there would be $2,195,047 waiting for her when she retires at age 65!
And since you chose the Roth IRA, which grows tax-free, she won’t be taxed when she takes money out of the account.
Investing for Your Child’s Future Expenses and Experiences
Maybe you’re thinking about investing for things that aren’t too far into the future. After all, your children will go through a lot of important—and expensive—events and milestones in their 20s and 30s.
If you want to save or invest money to help your child out with adult expenses or a down payment on their first house, you’ll want to put that money in an account that’s a little more liquid (or accessible) than a Roth IRA.
These accounts won’t have the time—or tax breaks—to grow like a Roth account, but your kids will be able to access the funds penalty-free when they need them for major life events.
1. Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA)
If the account you want to open for your child is one you’re not planning to touch for five years or more, you can consider a Uniform Gifts to Minors Act (UGMA) or a Uniform Transfers to Minor Act (UTMA) account to invest in good growth stock mutual funds. Here are some of the key things you need to know about these accounts:
- Just like with a Custodial IRA, UGMA and UTMA accounts are opened in a child’s name and a custodian is named—usually a parent or grandparent. But you can choose anyone to manage the account.
- The custodian will have full control of the account until the child reaches a certain age.
- UGMA and UTMA accounts are often used to save for college—after ESAs and 529s—but the money can be used for anything.
- There are some tax advantages to using UGMA and UTMA accounts. Since they’re in your child’s name, the accounts will be taxed according to their tax bracket. The lower tax rate for children means they’ll pay less in income taxes.
- There are no contribution limits on UGMA and UTMA accounts.
You probably have some thoughts on how you want your kids to spend the money you’re investing for them. Well, keep this important thing in mind: Once your child is old enough to take custody of the account, they can do what they want with the money. This may be fine with you, but make sure you’re teaching your kids good financial habits so they’ll be prepared when they inherit the account.
2. Money Market Account
If the idea of basically handing your kids a blank check makes you nervous, you can open a money market account in your own name and save over time until you’re ready to gift the money in the account to your kids. Technically this isn’t investing, but money market accounts are really great for short-term savings goals (as in five years or less).
They have low interest rates, so your return won’t be much, but you will be in control of when and how your kids receive the money you plan to gift them.
Investing in Your Child: One Last Thing You Should Know
No matter how you plan on investing for your child’s future, it’s important to sit down with your kids when they’re old enough and share your heart behind your gift. Clear communication about the expectations for this money can save you from dealing with family drama around the dinner table during Thanksgiving!
Giving an immature high school or college grad access to thousands of dollars is like handing over the keys of a Ferrari to someone who just passed their driver’s test yesterday. You’re setting them up for a nasty crash. If you want your financial gift to be a blessing and not a curse, make sure you’re teaching your kids the value of hard work and responsibility. They should have the character, maturity and wisdom to be a good steward of the financial gifts you are entrusting to them.
Work With an Investment Pro
Ready to start investing for your kid’s future? Get the help of an experienced investment professional to walk you through all the options. Our SmartVestor program can connect you with a trustworthy pro who can help you reach your investing goals.
ABOUT THE AUTHOR
Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.