Disclaimer: I am not a tax professional, but I do make comments on taxable ideas here. Please consult a tax professional to see if this is right for you and your family.
Since my wife and I had our first child, I thought it was important to outline 3 different types of accounts available to open for a newborn. Here is a list and some explanations on accounts that I think are important to open per child.
- 529 Account
- A 529 Account is a tax-free account if it is used for educational expenses. The most recent tax law expanded educational expenses to include K-12 tuition.
- The money that is put in does not give the parents a tax deduction, but the growth of that money is not taxed if used for tuition, or qualified education expenses.
- A 529 can also be transferred to another child if one child is more likely to go on to additional education than the other.
- Anyone can add to a 529, and most 529 providers have a link that you can send out to family and friends for birthday gifts.
- College expenses are expected to be around a total of $400,000 in 18 years when our child is expected to go to college, given the current tuition inflation rate.
- In order to meet the $400,000+ expected college expenses with a 529, the family would have to deposit initially almost $50,000 with an expected growth rate of 10%.
- The family could also add approximately $5,600 per year or $466 per month for 22 years.
- This is asking a lot from parents, and it is likely college will change to some degree. Parents also should not be expected to cover full college expenses, as it is beneficial for grade outcomes for students to work around 20 hours per week and learn some time management while on their own.
- Those numbers I mentioned are maximum goal numbers, do what you can without jeopardizing your retirement. Your kids have the best asset, time, which parents by definition have less.
- The worst case scenario is that it does not get used, the parents can then take out the proceeds and the gains are taxed at income rates.
- A minor Roth IRA is probably the best way to grow money for your child, but it requires them to do work. This is more at the parent’s discretion, but when a child has earned income, they can contribute to a Roth IRA up to the amount of income they have earned or $6,000, whichever is lower. For example, mowing lawns, lemonade stands, babysitting, dog walking, or modeling. This can include doing work around the house, but only if they do it regularly for other people as well.
- Keep good documentation on what was performed and when. The child does not have to file a tax return since a full contribution of $6,000 is under the taxable income limit. In case of an audit, it would be very helpful to have a spreadsheet of what the child has done.
- To take a step further, parents can make a match for your child. If they are working and they want to save some money, then match what they are saving in their Roth.
- We also like to see parents help the child pick the stock, learn about the company, and track returns. Your child, when they are of age, can join one of our Stock Market Game Groups.
- A UGMA is a standard brokerage account that the parent can help direct. The money is directed by the parents until they reach the state's age of ownership, however, the money is technically the child's.
- UGMAs are ideal for any money received that does not qualify as earned income. or anything that they might want to use with no strings attached.
- I prefer non dividend-paying stocks in these accounts to minimize tax filing obligations.