The 5 best saving and investment accounts.
Each account for your kids should play a specific role.
There are several considerations that come with each account type.
Time is your most valuable asset - the sooner you implement a savings plan for your kids, the more time that money has to grow and compound.
You’re sitting on some cash for your kids and not sure what to do with it. Whether it’s cash from a birthday gift or earned income from a job, it should be working for them in some way. With that word inflation being thrown around lately, their money is either working for them or against them.
So, which account is best? It depends on the goal.
While I’m a huge advocate for teaching kids about money along the way and eventually getting them involved in the decision-making, opening the accounts is usually up to us parents.
It’s not what you make; it’s what you keep. Choosing the right account(s) for your goals will help you keep more of what’s yours.
High-yield savings account
A high-yield savings account will provide the best bang for your buck on cash. It should be used for any immediate or planned near-term expenses – gaming system, car, or upcoming tuition payment.
High-yield savings instead of CDs? For now, yes. The Fed’s interest rate policy has a direct impact on banking products. As interest rates go up, the interest rate on high-yield savings accounts will also go up while the rate on your CD is locked.
Uniform Transfers/Gift to Minors Act (UTMA/UGMA)
Also referred to as Custodial accounts, this is a brokerage account owned by the minor but managed by a guardian as trustee. The trustee has a fiduciary responsibility to manage the account in the best interests of the minor. You would consider using this account for non-education goals with a longer time horizon (3+ years).
When the minor reaches the age of majority (between ages 18 and 25, varies by state), they have the right to take full control of the account. The trustee is removed, and the account then becomes an individual account for the (then) minor.
529 Savings Plan
When it comes to education savings, 529 Plans are usually the first choice because they offer great tax efficiency, generous contribution allowances, and flexibility.
529 Plans are state-sponsored plans where a guardian owns the account for the benefit of a student. If your state offers Direct and Broker-Sold 529 Plan options, you should use the Direct option because the Broker-sold Plans can be 5 to 10x more expensive for the same investment program.
You are free to use any state’s Plan, but your resident state may offer a state income tax benefit for using its Plan. The biggest perk of a 529 Plan is tax-free growth for qualified education expenses. While balances can be used for grades K through 12, there is an annual maximum withdrawal of $10,000 for pre-college expenses.
Coverdell Education Savings Account (ESA)
ESAs are a great under-the-radar choice for education savings goals. These accounts are also owned by a guardian for the benefit of a student.
Like 529 Plans, balances grow tax-free for any level of education. Unlike 529 Plans, there isn’t an annual withdrawal limit for pre-college expenses, and you are not limited to a menu of investment options. Just like a regular investment account, you can invest an ESA however you’d like – ETFs, mutual funds, individual stocks, etc.
The downsides to ESAs are the income eligibility requirement and the annual contribution limit of $2,000.
Minor Roth IRA
Want to give your child a head start on retirement? A Roth IRA is a very powerful way to do that.
When it comes to investing, time is your most valuable asset. Every dollar invested at age 15 has the potential to become $118. Let that sink it - that’s not a typo. Assuming retirement at age 65 and annual historical average S&P 500 returns of 10%, each dollar has the potential to grow 118x.
The best part? It’s completely tax-free. Every penny is theirs.
So, did they make any money this summer? Babysitting, caddying, cutting grass – they can contribute 100% of that income up to the annual IRA contribution limit of $6,000.
“What if they need the money before age 59 ½?” They have immediate access to the contribution amount tax and penalty-free. For example, if the account is worth $25,000 but they’ve only contributed $10,000, they can access the $10,000 at any time without any tax or penalties.
These are all great accounts. All of them can be a part of your strategy with each account playing a specific role in the overall plan.
Here is a table summarizing the considerations for each account type:
While there are plenty of account options, there are also plenty of considerations. Each account has its own set of pros and cons that need to be considered when determining what role, if any, it will play. As a planner, I like to think with the end in mind and reverse engineer from there.
Time offers the power of compounding, but it also offers options and flexibility. When you plan early, you give yourself more, optimal options. If you’re reacting, you run the risk of having to choose the least bad option.
Your retirement needs a plan. Your kids' money deserves a plan, too.
Frank Iozzo, CPWA®
President, Private Wealth Advisor