Kid’s Investment Accounts: How to Choose

Kid’s Investment Accounts: How to Choose

One of the more frequently asked questions we get is where to invest money for our clients’ minor children. There are many options to choose from, each with its own benefits. I’d like to take a few minutes to walk through the top three vehicles and the pros and cons of each.

The three most commonly used child investment accounts are 529s, Trump Accounts, and UGMA/UTMA accounts. Each has its own nuances and benefits. My hope is that after reading this, you’ll know the best place to put that birthday money, or extra scratch, for the benefit of your children.

529 Accounts —

These are better known as college savings accounts. They’re fantastic vehicles if the purpose of your savings is to sock money away for college or some other form of higher education. With many universities eclipsing $400,000 already, I understand the desire to put away as much as possible. These 529 accounts essentially work like Roth IRAs for college. They’re funded with after-tax dollars and grow tax free, with one major caveat: the funds must be used for higher education costs for your child or any blood relative of that child. If not, there can be a hefty 10% penalty plus ordinary income tax on the growth. Used on higher ed, though, those funds come out tax free, growth included.

These are great vehicles for college but naturally fairly rigid if you want flexibility. It’s worth noting that given the exorbitant cost of college these days, every little edge you can get goes a long way.

UTMA/UGMA Accounts —

Uniform Gift/Transfers to Minors Accounts are basically what they sound like: brokerage investment accounts set up for a minor. You can invest however you’d like, much like a 529, but there are no tax benefits for your children (or you). They’re treated much like your adult brokerage account, just routed through the UGMA channel since the owner is a minor. The nice benefit is there are virtually no restrictions on what these funds can be used for. A car, a house, college, beer money, vacations, whatever your child would like. At the age of majority, which is state specific, these funds become 100% your child’s, giving them unfettered access to the entire account. That can be a really good thing, or a potentially bad one, since the parent has no ability to prevent them from using the funds once they reach adulthood. So if you’re worried they’ll use it to buy their high school girlfriend a nice promise ring, or a stack of baseball cards, there’s not much you can do to stop it.

Trump Accounts —

I recently wrote about these new accounts, as they’re quite fascinating. They’re funded each year with after-tax dollars as well, then grow basically tax deferred for the benefit of your child. At 18, these accounts essentially become an IRA (or a Roth, if you make a conversion), and become theirs from that point forward. Think of them as an IRA before your child is even eligible for one. It’s a great way to get ahead and start building that retirement nest egg while they’re young, giving them a real advantage when they hit the real world with retirement savings already in place. The downside is they’re the most restrictive of the three. They basically follow the same hardship and withdrawal rules as an IRA, which are not fun. So while these are fantastic new vehicles, make sure you assess your child’s future needs before funding one over something with more flexibility.

Decisions, decisions, decisions.

There you have the different types of accounts I most recommend for minor children. I’ve used each of them myself and see validity in all three. I highly recommend deciding who’s funding the account, how the funds will be invested, and, most importantly, what your end objective is. From there, you can work down the decision tree to find the right fit for you and your children. Naturally, if you get stuck, we’re here to help you think it through.

As always, stay wealthy, healthy, and happy.