Want to know how to ensure your child’s financial success in the future? One of the best ways to set your children up for success is to start saving for their future now. It’s incredibly beneficial to invest at a young age because they have time on their side, meaning compounding interest has plenty of time to do its job.
Here are three ways to invest in your child’s future.
529 plans are a powerful tool to save for a child’s college costs. The funds in the account grow tax-deferred, and no taxes are due on withdrawals when used for qualified education expenses, including tuition, housing, and supplies. Qualified educational expenses also include trade schools and up to $10,000 per year for K-12 tuition and $10,000 in student loan repayments.
Anyone can contribute to your child’s 529 plan, making it a great gift idea. There are no annual limits, but contributions are considered gifts for tax purposes. Each donor will likely not want to contribute more than $16,000 per year (2022) to stay under the annual gift tax exclusion amount. A larger lump sum contribution can be made under the assumption that it covers the next 5 years of contributions, ex. $80,000 in 2022.
Although a child may not fully understand the impact of your current contributions,
investing now can make a huge difference in their financial future.
A custodial account is a great way to save for your child’s future that does not require the funds to solely be used for educational costs, although it does not have the tax benefits and control that a 529 plan has. It’s important to know that the ownership of the account will transfer to the child at the legal age of adulthood, 18 or 21 depending on the state, so the donor no longer will have control of the funds or how the recipient spends them.
Gifts can be in cash or investments such as stocks, bonds, and mutual funds. There are no contribution limits, but gifts into the account are irrevocable. Assets in a student’s custodial account will reduce their eligibility for need-based financial aid for FAFSA®.
Starting a Custodial Roth IRA for a child under 18 can jumpstart a minor’s savings for retirement, providing decades of tax-free growth and future tax-free distributions. Roth IRA owners are able to take their contributions out at any time without taxes or penalties, and distributions taken after age 59 ½ or for qualifying events, such as up to $10,000 for a first-time home purchase, are tax-free.
The key is that the minor must have earned income, either from a job or self-employment, to contribute to the Roth IRA, making this a great option for children that have summer jobs or work for the family business. In 2022, the maximum contribution is the lesser of the child’s total earned income, or $6,000. Like a custodial account, the adult maintains ownership of the account until the child turns 18 or 21.