I know one of my biggest goals as a parent is to provide a college education for both of my kids, like what my parents did for me. Just because that is my goal, doesn’t mean that is right for everyone. However, if you are reading this article, there is a good chance you are already thinking about how to prepare for your child’s future.
There are many different options including 529 college savings accounts, a simple stock account for your child, or a standard savings account.
The short answer, you can’t go wrong when it comes to investing in your child. Any money you set aside in any type of account is fantastic. However, there are a few things to think about with each scenario I will go over to help you decide what the best investment plan for your child’s future is.
Below is a quick list of what we will cover today.
- Pros and Cons of a savings account
- Pros and Cons of a 529 college savings
- Pros and Cons of a stock account for your child
I want to keep this one short and sweet. To be clear, there is absolutely nothing wrong with having a savings account for your child. There is absolutely no risk to putting after-tax dollars in the account; no matter what happens, that money will be there.
However, there is also absolutely no upside to having a savings account. What I mean by that is your money has no real opportunities to grow. There are always risks with investment accounts that your money could go to zero, but if you are careful, I would say that risk is extremely minimal.
If you have no ambition in creating a 529 savings account, or a small stock account for your child, get them a savings account. Every dollar you can save for them in their early years is a dollar that can help them get their lives started or help them pay for a college education. A savings account may not be the best investment plan for your child’s future, but it’s still a plan, which is better than no plan.
But, if you are truly interested in investing for your child and getting the most bang for your buck, pay close attention to the next two options I am going to talk about.
529 College Savings:
Before getting too deep into a 529 college savings account, I will note that each state can have varying rules and regulations. For most circumstances what I share below will be accurate, but you should do your research based on the state you are located in.
Please note, a 529 savings account is not a stock account, but a savings account that is typically invested into mutual funds. If you are looking for the best investment plan for your child’s future, and you don’t believe they will attend college, a 529 account is not what’s best for you. Please consider a savings account from above or a kid’s stock account that will be covered below.
A 529 plan is simply a savings account that can be used for educational purposes only. That may be tuition costs for a private education from kindergarten through twelve grades and also includes tuition or student loan repayment for a college education.
Any person who has a social security number or Tax ID can be a beneficiary of a 529 account, it does not matter their age. As soon as both of my kids were issued social security numbers, I opened 529 accounts with them as the beneficiary. The person opening the account must be over the age of 18.
As with any type of investment account, you can get creative on how you want to invest the money in the account. I will tell you though, there are some great mutual funds based on your child’s expected year to begin needing the money.
Example – My daughter is scheduled to start college in 2038, so most of my money is in a mutual fund that is geared towards the money being taken out around that time. Full disclosure, I open most of my own retirement and college savings accounts, but I let the experts pick the investments.
You can certainly open your own account and invest the money as you please, but a financial advisor is always great for these services.
Cons of 529:
Truthfully, not a ton of cons when it comes to a 529 account. However, there are still some risks that you should be aware of.
The biggest risk, in my opinion, is if your child receives a full-ride scholarship, you will likely have to pay a penalty to get the money out for anything other than school-related activities.
If you withdraw from this account and it isn’t used for any type of education or education expenses, you will be liable for a 10% federal penalty tax. There is also a possibility of a state or local tax depending on where you are located.
Another slight caveat is you can’t have multiple beneficiaries on a 529 account. The reason I mention that is I was originally wanting to just create one 529 for both of my children. That way if one’s education costs more than the other, I had much less risk of putting too much money in an account and having to pay the tax to take it out.
In my opinion, this isn’t a huge issue, but certainly something I wanted to mention.
Pros of 529:
The biggest pro of a 529 is the tax advantage it gives you. Contributions are all after-tax dollars, but if the money doesn’t leave the account, there are no taxes on the earnings from the account.
That means if you put aside $150/month for 18 years, that $32,400 of investment could easily be $50,000 to $70,000 depending on how the mutual fund performs and you will have no tax implication on the gains.
I mentioned above that one con of a 529 account was the limitation of the funds towards educational purposes. However, knowing that the 529 must be used for education, there is some leniency and flexibility on how the money can be spent in that quadrant.
It doesn’t necessarily just have to be college tuition. This money could be used for books, certain costs if you take an internship for credit, or even student loan debt down the road. There are certain limitations, but if you find your child has received a ton of scholarships, there are different options for finding ways to spend the money without penalties.
Let’s be honest, paying a fee to get the money you never thought you would see back again, wouldn’t be the end of the world! You may pay a penalty, but you still wouldn’t have to pay a tax for the gains in the account.
My favorite part of a 529 college savings account is how easy it is to contribute to, and there are very minimal limitations to the amounts you can contribute per year. A single person can contribute up to $75,000 per year and a married couple $150,000 per year without paying a federal gift tax.
What I do for my kids, is send out the 529 information to family before Christmas and Birthdays. Family members can then send checks to my financial advisor’s office and he puts the money directly into their accounts.
This way the kids can turn their $25 birthday money into thousands if the money is in the right funds. Also, Grandpa and Grandma know exactly where the money is going and don’t have to wonder if their son is buying something on behalf of the kids (I would never do such a thing).
Overall, a 529 savings account is a great investment plan for your child’s future, if you know your kid is going to go to college. Obviously, that is tough to know when they can’t think for themselves, so the biggest thing to be careful of is not contributing too much.
Another great investment plan for your child’s future is a separate stock account in their name. The way this works (in my experience), is you would open the account under the parent’s name (someone 18 or older with a valid social security number), and then make the child the beneficiary.
This account would then be no different than your personal stock account. You can put a chunk of money in and invest, you can put small amounts weekly and invest when you like, and you can buy and sell as you please.
This option allows your money to “do the work for you”, but also has some negative side effects that you’ll want to think about.
Cons of a Stock Account
One of the bigger things you’ll want to think about is the cost your children could have with a stock account. If you continue to put money into this account, they will have to pay capital gains on the money if they ever want to take it out.
I get it, that’s a real “first-world” problem having to pay taxes on the gains the account has made, but an 18-year old kid who gets a stock account handed to them at graduation may not fully understand how that works.
You may have contributed $20,000 over their life span and it’s now worth $35,000, which is fantastic. But when your child files their taxes for one of the first times (possibly), they’ll be shocked when they see they must pay back a big chunk of that money.
Again, this is not a reason to not start a stock account for your child, but something to think about, and something to explain to them as they get older and possibly consider cashing out a few of the shares in their account.
There is risk in anything you do, but I will say the risk is slightly higher for a negative impact on a stock account for your child compared to a 529 savings account.
The 529 mutual funds usually grow anywhere from 5-10 percent annually, with much less risk of dying off. If you don’t choose your stocks wisely, you have a greater chance of hitting a dud that either doesn’t grow or completely goes bankrupt.
I personally have two stock accounts for each of my children, and the pros certainly outweigh the cons.
Pros of a Stock Account
The biggest pro of a stock account for your child is the endless gain opportunity. If you catch the right stock at the right time, you could literally double or triple your money in a single year.
When my first was born I purchased three shares of Amazon (AMZN) for her. At the time the stock was trading right around $1,300 per share. Since then the stock has nearly tripled and has been as high as $3,600 per share.
While that scenario worked out great, there are several others that could have gone south as well. As with any investment, do your research before buying any stock, and continue to follow the company, and make sure they are positioned for a bright future.
The last positive note I want to touch on is giving your child the ability to be involved in the account and learning about the stock market as well. I’m not saying you let your 16-year old have full control of the account, but you can certainly show them how things work and even let them invest some of their own money.
This would be the perfect opportunity for your son or daughter to research a company they are interested in and make the pitch to you on why you should invest. Understanding how the account works before fully taking it over will be extremely beneficial.
In my opinion, the best investment plan for your child’s future is a combination of all the above. This helps limit your risk and keeps your child’s portfolio diversified.
Savings: Open up a savings account for your child right away. Start it with a small amount of money and don’t necessarily worry about growing it, especially while they’re little. If they get $5 here or $10 there, a savings account is a great place to stash that type of cash.
Eventually, as they get older this will be their first access to understanding how to save and spend money. I know as a kid (once I was 12 or 13), my parents allowed me to make all decisions with my savings account. There was usually only $75-100 in there, but it really taught me how to save and be careful with what I was buying.
529 Savings: As mentioned before, if you know your child will attend school, this should be a top priority. But there is such a thing as putting too much money in a 529. Remember, this money is earmarked for educational purposes only, so you don’t want to pay a penalty to take money out for non-educational uses.
I started with $150/month for each of my children. If I never change the amount that is over $32,000 they will have upon graduation. Assuming my mutual funds perform at a normal level, that money should be equivalent to $60,000 or more in 18 years.
Now, unfortunately, there is no way that will pay for four years of school, but it’s a great start. Contributing more than $150 per month right now just isn’t an option. But as I continue in my career and hopefully make more money, I’ll consider increasing my contribution.
The 529 is where I focus most of my attention because of the tax benefit.
Stock Account: I also recommend a stock account for your child as well. For me, this is the account that I contribute to when I get a chunk of money. Maybe it’s a bonus at work, a month I got paid three times, or even a tax return.
Anytime I see my checking account get more than it needs in it, I feed it into their stock account. My goal is to try and give at least $600 a year to this account. It won’t always happen, but some years will also have bigger contributions than others.
That $600 a year is another $10,000 your child will have at their disposal once they turn 18, and if you choose your investments wisely it will likely be worth at least double that. Remember, there are just maybe some taxes that you need to account for.
As I stated from the beginning, there is no wrong “best investment plan for your child’s future”. Some options may have more upside than others, but only do what you are comfortable with. A savings account, 529 savings, and/or stock account are all great options to start investing for your child early in life.