If you’re a parent, then there’s no doubt you want the best for your kids. Indeed, we all want our children to do better than us. But where do you even start? How do you begin investing for kids?
Believe it or not, it’s easier than you might think. In fact, if you play your cards right, you can help your kids become millionaires!
It all comes down to the eighth wonder of the world: compound interest. And there’s a lot you can do! You can help your kid obtain a college degree, jump-start retirement, or even set aside an amount to give later.
And the best part? You can start at any age! Of course, if you know how compound interest works, then you know the earlier you start, the better!
Real Quick: Some Resources for You!
Before we go deep into investing for your kids, I want to showcase a couple of resources for you.Try Audible and Get Two Free Audiobooks
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First off, I want to introduce you to The Total Money Makeover by Dave Ramsey. Without a doubt, this is one of the best books out there on taking control of your money. He even goes into investing for your kids’ future! Seriously, this book changed the way I do finances, and I believe it will help you, too.
If you want your kids to graduate from college without debt, then this is the book for you! Debt Free Degree by Anthony ONeal is a great resource to avoid the trap that is student loan debt. Plus, this book lays out a practical strategy for parents who want to invest in their child’s future!
And of course, if you want to learn a proven strategy for getting out of debt, check out my FREE eBook! This 23-page guide will help you build a strategy to help you win with your money! Just enter your email below and I’ll send it right to you!
Now, let’s take a look at how to start investing for your kids’ future!
Before You Start Investing for Your Kids’ Future, Invest in Yourself
This is a step many parents neglect. But it’s essential if you really want to start investing for your kids’ future.
Before you can truly help your children with money, you need to be in a good spot yourself. In other words, if you’re not financially secure, you’ll find it difficult to help them.
Otherwise, you’ll find yourself struggling to stay afloat. And if don’t save for your own retirement, you could end up placing a burden on your children later. Hopefully, no parent wants to do that.
As the old saying goes, put on your own oxygen mask first. Start investing for yourself first. Then you can start investing for your kids.
The Best Ways to Start Investing for Your Kids’ Future
As you can imagine, there are a lot of ways you can start setting up your kids for success. However, as you can imagine, some ways are better than others. And some ways just are.
Ultimately, it’s up to you. But I always answer questions the the attitude of, “What would I do?”
So, here’s a few things I personally plan to do once we start popping out kids!
1. Start Investing for Your Child’s Education
By a show of hands, how many of you came out of college with student loan debt?
Don’t student loans stink? I sure think they do. Therefore, I definitely don’t want my kids to go through that. And I’m betting you don’t want your kids to go through it, either.
So, where do you start? Fortunately, there are a couple of really good options for you!
I want to introduce you to two friends of mine: the Coverdell Education Savings Account (ESA) and the 529. Both are great ways to start investing for your kids’ future!
What is a Coverdell Education Savings Account (ESA)?
Named after the guy in Congress who advocated for it, an ESA is a tax-advantaged account for education expenses. That means the money grows tax free! Plus, there are no taxes as long as you use it for education expenses.
However, there are some nuances you need to be aware of. Below are some of the common questions about ESAs.
Are there contribution limits to the ESA?
Yes, you can only contribute $2,000 per year for each child. In other words, each child can have an ESA and you can contribute $2,000 per year to each of them.
Does my child have to use the ESA before a certain age?
Yes, your child must use the money before age 30. You can also give it to another family member for education expenses. Otherwise, you’ll face tax penalties.
Are there income limits?
Yes, you cannot contribute to an ESA if you make more than $110,000 per year if single, or $220,000 per year if married.
Can you use an ESA for noneducational expenses?
Well, you can. But I would encourage you not to. Because if you do, sketchy men in black suits will come and steal…I mean, *ahem*, collect taxes.
Do I have to use the money for a four-year college?
Nope! You can also use your ESA for qualified K-12 expenses as well. You can also use it for a two-year college or vocational school.
What if my child doesn’t go to college or doesn’t need an ESA?
You can transfer the ESA to another family member.
How do I open one up?
The best way is to speak with an investment professional. They’ll help you discover the best way for you to invest your money and meet your goals.
What is a 529?
Essentially, a 529 is an investment account your child can use for education expenses. You can open one up as soon as your child has a social security number.
A nice benefit is that the earnings on a 529 grow tax-free! In other words, as long as you use it for qualified expenses, there’s no tax bill. I don’t know about you, but I don’t like giving the government more money than I have to!
Also, a 529 isn’t just for college. You can also use the money for K-12 education expenses!
Below, I’ve answered a few common questions about 529 plans.
Are there contribution limits to 529s?
No, there are no contribution limits to 529 plans. However, if you contribute more than $15,000 per year, it will be subject to the federal gift tax (as of 2020).
Does my child have to use the money before a certain age?
Nope! It’s theirs for life and they can use it at any time.
Are there income limits?
No, you can open up a 529 regardless of how much you make.
Can I use the money from a 529 for noneducational expenses?
Well, it’s your money so you can do whatever you want with it! However, the Gestapo…oops, I mean the IRS will hit you with a 10% penalty. Plus, whoever receives the money will have to pay income taxes.
Do I have to use the money for a four-year college?
Nope! I’ve already mentioned that you can use the money for qualified K-12 expenses. But you can also use it for vocational or trade school, 2-year colleges, apprenticeships, homeschooling expenses, and more!
What if my child doesn’t go to college or doesn’t need the 529?
Good news with this one, too! You can roll that money over to another family member without a penalty. You can even use the money to further your own education. Your child can even use if for their children later!
Am I restricted to my state’s 529 plan?
Absolutely NOT! You can use any state’s 529 plan.
Should I use the College Savings Plan option or the Prepaid Tuition option?
100% you should use the College Savings Plan option. STAY AWAY FROM PREPAID TUITION OPTIONS!!!! Here’s why: the College Savings Plan option works much like a Roth 401k or Roth IRA. You contribute the money and choose your investments. Then you reap the benefits!
I don’t recommend Prepaid Tuition simply because you don’t know what the future holds. Your child may decide to go a different route other than college. And if that happens, most states only refund the principle you contributed. You lose any interest earned. Plus, it you can’t transfer it to a sibling or other family members. Therefore, it’s a waste of time and money.
How do I open one up?
Good question! I recommend talking to an investment professional to find out what’s best for you. They can help you shop around for multiple 529 plans to determine what’s best for you.
Should I Use an ESA or a 529?
Truthfully, either one is an excellent choice for investing in your kids’ future. Both of them are investment vehicles, which means you get to take advantage of compound interest.
Let’s look at the ESA just as an example. Let’s say you and your wife have a child and open up an ESA before they even turn a year old. You decide to contribute $2,000 a year until they turn 18 years old. That means you would have contributed a total of $36,000. Assuming an average return of 10%, you would end up with $91,198! Not a bad start, right?
And if you do a 529, you have even more options and can contribute more!
However, unless I can talk to you for over an hour, I couldn’t tell you which one is best for you. There are just too many nuances with each. But you can go ahead and sit down with an investment professional to weigh the pros and cons of each!
However you look at it, this provides a fantastic way to start investing for your kids’ future. And you can start as soon as they’re born!
2. Contribute to Your Child’s Future Retirement with a Custodial IRA
Looking further into the future? Then helping your child get a head start on retirement is something you might want to look into!
But I will say this: to take this route your kid will have to get a job. That’s because they have to have an earned income in order to open up an Individual Retirement Account (IRA).
That’s right! You can open up a Custodial IRA for your child once they start earning some cash.
However, they won’t be able to contribute more than they earn. So if they earn only $4,000 per year, then they won’t be able to contribute more than $4,000. That also means you can’t make up the difference for them.
Traditional IRA vs. Roth IRA
You’ll have a choice between opening up a traditional or a Roth IRA for your child. So, what’s the difference?
Basically, with a traditional IRA you put the money before you pay taxes on it. Your child’s earning will continue to grow until they can begin making withdrawals (at age 59-and-a-half). After that, they will tax the withdrawals as income.
With a Roth IRA, you put in money after you’ve already paid taxes. The money continues to grow tax-free until they can start taking distributions (again, at age 59-and-a-half). However, unlike the traditional IRA, with a Roth IRA you don’t pay taxes on distributions. That’s right! You won’t get a tax bill for withdrawals from a Roth.
Therefore, my recommendation is the Roth IRA. That way, your child’s earnings continue to grow tax free for the rest of their lives.
How a Custodial IRA Works
When you open up a custodial IRA, it will be in your child’s name. However, you’ll have to manage the account until they reach a certain age. Depending on what state you live in, it will be until they reach ages 18 or 21.
In order to open up a custodial IRA, your child must have an earned income. And no, I don’t mean money you give them for taking out the trash! They need a job, whether that’s working at Chick-fil-A, babysitting, tutoring, or anything where other people pay them!
As I mentioned earlier, they are also subject to IRA contribution limits. That means they can put in no more than $6,000 per year (as of 2020). Nor can they contribute more than they earn each year. So if they make only $2,000 during a year of tutoring, that means they can only contribute $2,000 that year.
Then how do I contribute to my child’s retirement?
Good question! Here’s what I recommend: offer to match whatever they put in. That way, this could also end up being a budgeting lesson for them. They can decide how much they want to spend, to give, and to invest. This will help set them up for success in more way than one.
For example, let’s say your child earns $500 one month for cutting grass. They tell you they want to use $150 of it for investing. You then match it and put another $150 into their Custodial Roth IRA. If they do this every month, they’ll have $3,600 by the end of the year. Not too shabby!
I know that doesn’t sound like too much, but let’s take a look at how this could pan out. Let’s say that you start this when your child turns 16 and contribute until they turn 21. We’ll also assume an average return of 8%.
|Age||Money Invested||Account Balance|
|21 (Contributions Stop)||$0||$23,634|
There you have it! You could make your child a millionaire over time, even if they don’t invest anything else! Believe it or not, I actually estimated a little low. If your child’s investments manage to get 10% or even 12% over time, they’ll end up with even more!
Overall, this is a great way to start investing for your kids’ future. Just think, in the above scenario, you only contributed $9,000 over 5 years. Your child contributed the other $9,000. And the result is hundreds of thousands in tax-free growth!
3. Investing for Your Child’s Future Expenses or Experiences
Without a doubt, you’re aware that life is full of all kinds of expensive life events. Marriage, buying a house, and having children are all things that might come to mind.
But these provide yet another opportunity for you to start investing for your kids’ future!
When it comes to these expenses, you might want to look for something that’s not quite so stringent. After all, Custodial IRAs, ESAs, and 529s all have designations that don’t allow you to touch the money for certain things. That’s where just plain old investing and savings come in!
These would be shorter-term investments. As such, they won’t have the advantage of decades of long-term growth. However, they will be available to your child whenever they need them.
The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA)
If your child won’t need the funds for five years or more, consider opening up a UGMA or UTMA account for them.
Essentially, these accounts are just custodial investment accounts. They’re great because there are no contribution limits and allow you to choose your investments.
Here’s How a UGMA or UTMA Account Works
So, how does this work? Just like with the Custodial IRA, with UGMA or UTMA accounts you’ll need to name a custodian. It can be you, a grandparent, or really anyone trustworthy. The custodian will manage the account until the child reaches a certain age (as determined by state law).
Once the child comes of age, they will take full control and management of the account. Take note: they will be able to do whatever they want with the money.
There are also some tax advantages in that the taxes are charged according to your child’s tax bracket rather than yours. In all likelihood, that means your child won’t have to pay nearly as much in taxes.
So my kid takes control of the money when they reach a certain age…What if my kid turns out to be an idiot?!
We all hope our kids will turn out a certain way. But that’s not always the case. Indeed, even if you do everything right, your child can still wander in a different direction. And stupid with a pile of cash turns real stupid real quick.
But that’s part of the risk you take when it comes to this way of investing for your kids’ future.
I’ll say this too: it’s up to you to teach them how to manage finances wisely. As they grow up, they’ll watch you and your spouse on how you do money. Therefore, be wise in what you do with your money as well.
How should I invest the money?
Personally, I recommend mutual funds. These are safer than individual stocks and you can also choose your risk tolerance.
To get the best returns, spread your investments across four types of funds:
- Growth and Income: These are often called large-cap funds. They include large, stable companies that have a strong track record of doing well.
- Growth: Growth mutual funds will consist of your medium-sized companies, also called mid-cap funds. They could have some volatility, but also have room to grow.
- Aggressive Growth: These are your younger, up-an-coming companies. You’ll also see these called small-cap or “emerging market” funds. There’s a lot of potential for big gains, but the risk is also higher
- International: These funds will help you further diversify your accounts by investing in non-US companies. They’ll usually target companies like Toyota, LG, etc. they can also be small, mid, or large-cap as well.
Once you have your money spread across these four types of funds, your portfolio will have enough diversity to ensure growth.
However, I want to tell you a few investments that won’t do you much good:
- Single Stocks
- Certificates of Deposits (CDs)
- Real Estate Investment Trusts (REITs)
- Cash Value or Whole Life Insurance
- Precious Metals or Commodities
The “why” behind this is for another blog post. For now, you can check out this awesome blog post from Dave Ramey. But rest assured that if you stick to mutual funds for investing in your kids’ future, you’ll be okay.
The Ultimate Investment for Your Child’s Future
I’ve written a lot about money. But truthfully, money is just a small part of the legacy you leave for your children.
The true investment in your child comes from the time they spend with you. They will learn from you, glean from you, and ultimately become more like you.
Therefore, I ask you this: is your life worth emulating? Would you want your children to become more like you?
Of course, no one is perfect. We all screw up royally at some point. However, you can still lead a life worth repeating!
I implore you to instill in them the one thing that ultimately matters: Walking with and knowing Christ as Savior. Instruct them in the ways of the Lord and walk with them.
“These commandments that I give you today are to be on your hearts. Impress them on your children. Talk about them when you sit at home and when you walk along the road, when you lie down and when you get up.”Deuteronomy 6:6-7
“I have no greater joy than to hear that my children are walking in the truth.”3 John 1:4
“Children’s children are a crown to the aged, and parents are the pride of their children.”Proverbs 17:6
You can give your children all the money of the world, but lack in giving them love.
Therefore, love your children. Help them learn, grow, and point them towards Christ in all that you do.
And that is the ultimate legacy. One that will last for all eternity.
For what will it profit a man if he gains the whole world and forfeits his soul? Or what shall a man give in return for his soul?Matthew 16:26
Obtaining wealth is a good thing. Passing it on to your children is a good thing. But not at the expense of your soul.
Remember, money will not last for eternity. But your relationship with Christ will. And your child’s relationship with Christ will as well. Therefore, choose your ultimate investment wisely.
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Of course, I’ll always recommend Dave Ramsey’s The Total Money Makeover. This is the best book out there on personal finance. It changed the way I do finances, and I have to say that I couldn’t be happier!
Debt Free Degree by Anthony ONeal is a great resource to help your child graduate from school with NO DEBT! This is an easy-to-follow, step-by-step plan to help you explore ALL the ways you can go to school without taking out those pesky student loans.
And finally, if you need a quick read to jumpstart your debt-free journey, check out my FREE 23-page guide on how to get out of debt!