Investment Accounts for Children: A Guide for Future-Forward Parent

February 5th, 2024
by A Nanny Match

Investment Accounts for Children: A Guide for Future-Forw...

Starting the journey towards financial literacy and responsibility for children can set the foundation for a prosperous future. Investment accounts for children are not just a monetary gift; they're a practical educational tool that teaches the value of saving, the power of compounding interest, and the basics of investing.

At A Nanny Match, we are dedicated to positively impacting children's lives and providing valuable resources to parents and caregivers. This blog post will explore different types of investment accounts available for minors and how they work. 

Whether you're a parent, grandparent, or guardian, understanding how to invest for the younger generation can give them a financial head start.

Why set up an investment account for a minor?

Starting early maximizes the advantages, using compound interest to grow even small contributions into substantial amounts over time.


Custodial IRAs (Traditional and Roth)

Understanding Custodial IRAs

  • Custodial IRAs allow minors to have an IRA in their name, with a parent or guardian managing the account until they reach adulthood. These are ideal for children with earned income performing tasks like babysitting, lawn mowing, or working for their parents' business. Additionally, they can work in entertainment as actors or models with proper work permits and adherence to child labor laws.

Traditional vs. Roth IRAs

  • Traditional IRAs offer tax-deferred growth, while Roth IRAs offer tax-free growth. The choice depends on when you prefer to pay taxes – now (Roth) or later (Traditional).

Contribution Limits and Tax Implications

  • The annual contribution limit for 2023 is $6,000 (or the child’s earned income, whichever is lower). Traditional IRAs offer tax deductions on contributions, while Roth IRAs provide tax-free withdrawals in retirement.

We recently had the privilege of speaking with personal finance fanatic Katie Gatti Tassin, the voice behind the 'Money With Katie' blog and podcast, featured in the acclaimed Morning Brew newsletter with millions of subscribers. Katie, who also co-hosts the 'Bossy' podcast with tech entrepreneur Tara Reed, explores financial independence for modern entrepreneurs. Katie's ability to simplify complex financial concepts into actionable advice has garnered a dedicated following, and we're honored to share her insights.

Discussing the intricacies of involving children in business for the purpose of Roth IRA contributions, Katie provided a thoughtful perspective: "This is one of those tax law gray areas best left to a CPA to advise, but generally speaking, I've seen people employ kids as models for their business's photography and then pay them a reasonable fee that they then invest on their child's behalf in a custodial Roth IRA… legitimacy varies case by case, so if you feel like you're committing tax fraud by really stretching it, it's best not to risk it—and wait until your kid gets a real 'job' (even if that's babysitting or lawn mowing) to start contributing to their Roth IRA."

On encouraging children to invest, Katie offered a clever strategy: "My favorite trick is doing the old 'parental match.' Let's say your kid has a job that pays them $8/hour. Maybe they make a couple hundred bucks per month. If they're anything like me as a teenager, they'll revolt if you try to make them save all of it. But you can ask them to contribute half, then 'match' the amount they put in (so it's a legally permissible contribution based on their earnings)... establishing the habit and normalizing investing will go a long way."

529 College Savings Plans

What are 529 Plans?

  • 529 plans are tax-advantaged savings plans designed to encourage saving for future education costs. Federally tax-free, these plans are among the most popular ways to save for college.

Benefits and Limitations

  • The major benefit of a 529 plan is its tax advantage; earnings grow tax-free, and withdrawals for qualified education expenses are not taxed. However, funds used for non-educational purposes can incur penalties and taxes.

Setting Up a 529 Plan

  • You can set up a 529 plan through a financial advisor or directly with a plan provider. Consider factors like investment options, fees, and the impact on financial aid eligibility when choosing a plan.

Alli Williams, a prominent financial influencer, shares her expertise on 529 College Savings Plans in this section of our blog post.

Alli highlights the versatility of 529 plans by emphasizing their user-friendly features, stating, "One reason I love 529 plans is you can send a link to family/friends to contribute too. This is the perfect birthday, Christmas, or “thinking of you” gift for your child, and most 529 plans make it very easy to send a link via email."

Furthermore, she brings forth a forward-looking financial strategy by noting, "Starting this year, you can transfer unused 529 assets (up to a lifetime limit of $35,000) into the account beneficiary's Roth IRA. This is a great way to help your child save for retirement if you have extra funds in the account."

Trust Funds

The Basics of Trust Funds

  • Trust funds are legal arrangements allowing a trustee to manage assets for the benefit of a third party, the beneficiary. They can be set up for various purposes, including education, living expenses, or wealth transfer.

Types of Trusts: Revocable vs. Irrevocable

  • A revocable trust can be altered or terminated by the grantor during their lifetime, while an irrevocable trust cannot be changed once established. Each has unique tax implications and benefits.

Role in Estate Planning

  • Trusts play a crucial role in estate planning, allowing for controlled distribution of assets and potential tax benefits. They provide a structured way to manage and protect wealth for your child’s future.

UGMA/UTMA Accounts

Understanding UGMA and UTMA Accounts

Differences from Other Investment Accounts

  • These accounts are less restrictive about how funds are used compared to 529 plans or IRAs. However, they may have more significant tax implications and impact financial aid eligibility for college.

Tax Considerations

  • Contributions to UGMA/UTMA accounts are not tax-deductible, but earnings are taxed at the child’s tax rate, which is typically lower. However, once the child takes control of the account, large balances could be taxed at higher rates.

Choosing the Right Investment Strategy

Choosing the right investment strategy for your child involves considering several factors:

  • Risk Tolerance and Investment Time Horizon: Understand your risk tolerance and the time horizon for the investment. Longer horizons typically allow for more aggressive investment strategies.

  • Diversification: It's crucial to diversify investments across various asset classes to mitigate risk and optimize returns.

  • Monitoring and Adjustments: Regularly review and adjust the investment portfolio to align with changing goals and market conditions.

Teaching Children About Saving and Investing

Equipping children with financial knowledge is as important as investing for their future:

  • Age-Appropriate Financial Education: Start with basic concepts and gradually introduce more complex ideas as they grow older.

  • Encouraging Financial Responsibility: Involve children in discussions about saving and investing. Encourage them to save a portion of their allowance or earnings.

  • Lead by Example: Demonstrate responsible financial behaviors that children can emulate.

Getting Professional Advice

Navigating the world of investment can be complex. Seeking advice from a financial advisor can provide personalized strategies that align with your family's goals and

financial situation. They can also help you understand different investment vehicles' tax implications.

Disclaimer: A Nanny Match is not a financial advisor. The information provided in this guide is for informational purposes only and should not be considered financial advice. We strongly recommend consulting a qualified financial advisor or professional to determine the best investment strategy for your unique family and financial circumstances. Your financial advisor can provide personalized guidance tailored to your specific goals and needs.