Overview: Best Investments For Children | What You Should Know Before Opening Investment Accounts for Minors
What is the best investment account for child savers? Should you be looking at making financial investments for children, and if so, what is best? Children’s savings bonds, or a checking account, or perhaps your employer provides a college savings plan? Is there an investment account for child savers that you haven’t considered?
When it comes to thinking about investments for children, or if you’re wondering how to work out what are the best investment accounts for kids, it pays to get it right. The right decisions, made early, could make all the difference in creating real financial security and stability for your child, through childhood, high school, college, and beyond.
In this article, we present an overview on some of the options available when it comes to investments for children, from opening an investment account for child savers, purchasing children’s savings bonds, and looking in greater detail at some of the best investments for kids generally.
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Investments for Children: Options Available
To help you understand some of the options when it comes to the best investments for kids, we take a look at some of the more popular choices. In the sections below, we examine 529 Plans, including:
- College savings plans
- Prepaid tuition plans
- Custodial accounts
- Children’s savings bonds
- Simple savings accounts
A 529 Plan – the Best Investment for Children?
When it comes to the best investments for kids, surely education ranks highly. One of the best investments you can make for a child, therefore, is in their education. But what is the best way of doing this? And, if you’re planning to make an investment in your child’s education, does a 529 plan rank high in the list of potential investments for children?
Perhaps the answer isn’t so clear-cut. After an overview of how a 529 plan works, we look at some of the pros and cons.
According to the U.S. Securities and Exchange Commission (SEC), a 529 plan is “a tax-advantaged savings plan designed to encourage savings for future college costs.” They are called “529 plans” because they are authorized by Section 529 of the Internal Revenue Code.
There are two types of this plan: a Prepaid Tuition Plan and a College Savings Plan, and each plan represents a different but related opportunity to make investments for children.
According to the SEC, each state (and the District of Columbia) sponsors at least one type of 529 plan, and private colleges and universities sponsor a pre-paid tuition plan. This point is important because when it comes to choosing the child investment plans that represents the best value for you, you are not always restricted by where you live – so it is important to shop around.
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College Savings Plan
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A College Savings Plan is a tax-advantaged investment program that allows investors to save money, free from federal income tax, which can then be used to finance “qualified higher education expenses.” This type of child investment account offers a range of investment options that give a varying rate of return – often dependent on stock or bonds’ funds – though some plans do guarantee a minimum return.
College Savings Plans cover “all qualified higher education expenses,” including the following:
- Room & board
- Mandatory fees
- Books, computers (if required)
Many College Savings Plans have contribution limits exceeding $200,000 though it is important to note that, like many investment options, funds invested in this type of child investment account are subject to market risk, and may fall as well as rise.
529 Prepaid Tuition Plan
A prepaid tuition plan is a method first established in 1996 by which parents, grandparents, relatives, and friends can purchase future tuition fixed at today’s prices.
Amounts of tuition can be purchased with a lump sum or by monthly installments. It is worth bearing in mind that one feature that makes this one of the more attractive investments for children is that the pre-paid tuition can be used at any school or private college, anywhere in the country.
According to the Financial Industry Regulatory Authority (FINRA), some prepaid tuition plans cover between 1 and 5 years study and offer contracts for a two-year community college, a four-year course of undergraduate study, or even a combination of the two.
These types of child investment accounts differ from College Savings Plans in a number of ways, so it is important to do further research to identify which of the plans most closely suits your needs. Among the major difference is that Prepaid Tuition Plans “lock in” the cost of education at today’s prices and that many of these plans require either the owner or beneficiary of a plan to be a state resident. One other important consideration to take into account is the fact that, with only a few exceptions, the majority of prepaid tuition plans do not cover other expenses, such as room and board.
529 Plan Advantages
While there are some significant differences between both types of plan, one of the reasons they represent an attractive proposition among the wide range of available investments for children is the federal tax benefits they provide.
The Financial Industry Regulatory Authority points out that although the IRS usually only permits individuals to make gifts each year of up to $14,ooo to another person without being liable for federal gift tax, you can contribute up $70,000 to a 529 plan in any one year.
This is because a special tax law allows you to aggregate up to five years of the allowable $14,000 tax-free limit in order to “jump start” the 529 plan. While you won’t then be able to make any more gifts for five years, compounding will result in faster growth than if you paid in the maximum of $14,000 each year. This is one important way that a 529 College Savings Plan represents a shrewd option when it comes to a child investment account.
For more information on both types of plans, including a ranking service that allows you to make plan comparisons between states, you can visit the College Savings Plans Network.
Whichever you choose, 529 plans must surely rank highly as one of the best investment accounts for minors you could possibly make.
Custodial accounts are another type of investments for children, though there are some potential downsides. These types of account, which include Uniform Gift to Minors Act (UGMA) accounts and Uniform Transfer to Minors Act (UTMA) accounts, are tax-advantaged investment accounts for minors that help a parent, grandparent, or other adult save for a child’s educational expenses.
The Financial Industry Regulatory Authority website highlights some of the pros and cons. Among the advantages are the tax benefits applied to savings. In 2015, according to FINRA, the first $1,050 of unearned income in a custodial account is tax-free. The next $1,050 in unearned income is taxed at the child’s federal tax rate, as is earned income over $1,050. Unearned income over $2,100 is taxed at the custodian’s federal tax rate.
Custody Ending: Fast Car or College Education?
Custody of the account ends when the child reaches the age of majority. While these accounts may therefore represent one example among the many available investment accounts for kids, adults should bear in mind that, when the kid grows up, the accumulated savings may just as likely be spent on a fast car than education. When the beneficiary reaches the age of majority, they have full autonomy over how the money is spent.
Another potential downside, pointed out by FINRA, is that because the account is considered to be the child’s asset, it may have a larger negative impact on any future financial aid that may be due. It is also important to note that these accounts cannot be switched between beneficiaries, although the cash can be transferred into eligible 529 plans.
Good, Old-Fashioned Children’s Savings Bonds?
When it comes to investments for children, Savings Bonds represent another potential investment account for kids, but are children’s savings bonds worth it? And would you be thanked by parents for providing a savings bond for a child investor?
These bonds are backed by “the full faith and credit of the U.S. Government,” and the Treasury considers both EE and I Savings Bonds to be a solid addition to any investment portfolio, especially when used for education.
This is because interest from these bonds is tax-free if they are used for qualified higher education expenses, but income limits do apply and this means that, for some, children’s saving bonds may not rank high among the best investments for children.
But according to FINRA, for example, in 2015, the full interest exclusion on a Savings Bond for child beneficiaries is only available to couples filing jointly with modified adjusted gross income of less than $115,751, and for single filers with modified adjusted gross income of less than $77,200. This interest exclusion is phased out completely if modified adjusted gross income is over $145,749 for joint filers and $92,199 for single taxpayers.
For this reason, careful thought should be given by anyone considering purchasing a savings bond for child savers, because, depending on needs and circumstances, they just might not be among the best investment for kids.
The Best Investment for Kids?
All the child investment plans covered here have their advantages and disadvantages. As we have seen, the return on some 529 plans are subject to how well the money put aside has been invested, and although savings bonds offer some tax advantages if used for some educational expenses, there are income limits, too – so, for the wealthier, at least, when it comes to the best investment accounts for kids, it will pay to diversify.
One area worth exploring, no matter where you are on the income distribution curve, is a simple savings account. Indeed, this option could, surprisingly, turn out to be the best investment account for child savers that a parent could choose.
While the returns might not be particularly sizable, especially in such a low-interest rate climate, a simple savings account can, as a child grows, offer a great opportunity to begin teaching children about managing their money. Many banks offer incentives for children to begin saving, and it is worth shopping around to seek these out.
After all, just as it is important to find the right investment accounts for kids, it is also worth thinking about providing your child with a solid foundation in economic management, and one of the easiest ways to do this is via a simple savings account. A simple savings account just might, therefore, represent the most important investment account for child savers that parents can provide.
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